Question

Justin Cement Company has had the following pattern of earnings per share over the last five years: Year Earnings Per Share 20X1 $ 8.00 20X2 8.40 20X3 8.82 20X4 9.26 20X5 9.72 The earnings per share have grown at a constant rate (on a rounded basis) and will continue to do so in the future. Dividends represent 40 percent of earnings. a. Project earnings and dividends for the next year (20X6). (Round the growth rate to the nearest whole percent. Do not round any other intermediate calculations. Round your answers to 2 decimal places.)b. If the required rate of return (Ke) is 13 percent, what is the anticipated stock price (P0) at the beginning of 20X6? (Round the growth rate to the nearest whole percent. Do not round any other intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

Answer:

(a) $4.08

(b) $51.03

Explanation:

Constant growth rate for earnings:

= (EPS for any year ÷ EPS for the previous year) - 1

= (8.40 ÷ 8.00) - 1

= 0.05

= 5%

(a) EPS for 2016 = EPS for 2015 × (1 + 5%)

                          = 9.72 × 1.05

                          = $10.21          

Dividend for 2016 = 40% × EPS for 2016

                               = 40% × 10.206

                               = $4.08

(b) Stock Price at the beginning of 2016:

= Dividend for 2016 ÷ (Required rate of return - Constant growth rate)

= 4.0824 ÷ (0.13 - 0.05)

= $51.03