Question

Hancock Inc. retains most of its earnings. The company currently has earnings per share of $11. Hancock expects its earnings to grow at a constant rate of 2 percent per year. Furthermore, the average PE ratio of all other firms in Hancock's industry is 12. Hancock is expected to pay dividends per share of $3.50 during each of the next three years. If investors require a 10 percent rate of return on Hancock stock, a fair price for Hancock stock today is ___A) 113.95
B) 111.32
C) 131.49
D) none of the above

Answer 1

Answer:

D1 = $3.50

D2 = $3.50

D3 = $3.50

Ke = 10% = 0.1

Po = D1 +     D2 +      D3

      (1+ke)   (1+ke)2   (1+ke)3

Po = $3.50 +   $3.50  + $3.50

        (1+0.1)      (1+0.1)2  (1+0.1)3

Po = $3.18    +  $2.89  + $2.63

Po = $8.70

None of the above

Explanation:

In this scenario, we need to discount the dividend in each year by the required at rate of return of 10%. The aggregate of the price obtained as a result of discounting in year 1 to year 3 gives the current market price.