A company paid a $3.00 dividend per share on its common stock this past year. This dividend represented a 40% payout ratio. Dividends are expected to grow at a 6% annual compound growth rate while earnings are expected to grow at a 10% growth rate during the next 3 years. The P/E ratio is expected to remain at 12.
a) If a return of 12% is required during the next three years, what is a fair price today for each share of common stock?
b) If the common stock was selling instead for $85 today (rather than your answer in part a), what is the mimimum price the investor could accept at the end of the third year and still earn the required 12% return? (Assume everything else except the P/E ratio remains the same.)