Martin Office Supplies paid a $3 dividend last year. The dividend is expected to grow at a constant rate of 7 percent over the next four years. The required rate of return is 14 percent (this will also serve as the discount rate in this problem). Round all values to three places to the right of the decimal point where appropriate.
a. Compute the anticipated value of the dividends for the next four years. That is, compute D₁, D₂, D₃, and D₄—for example, D₁ is $3.21 ($3.00 × 1.07).
b. Discount each of these dividends back to the present at a discount rate of 14 percent and then sum them.
c. Compute the price of the stock at the end of the fourth year (P₄).

(D₅ is equal to D₄ times 1.07)
d. After you have computed P4, discount it back to the present at a discount rate of 14 percent for four years.
e. Add together the answers in part b and part d to get P₀, the current value of the stock. This answer represents the present value of the four periods of dividends, plus the present value of the price of the stock after four periods (which, in turn, represents the value of all future dividends).
f. Use Formula 10-8 to show that it will provide approximately the same answer as part e.

For Formula 10-8, use D₁ = $3.21, K_e = 14 percent, and g = 7 percent. (The slight difference between the answers to part e and part f is due to rounding.)
g. If current EPS is equal to $5.32 and the P/E ratio is 1.1 times higher than the industry average of 8, what would the stock price be?
h. By what dollar amount is the stock price in part g different from the stock price in part f?
i. In regard to the stock price in part f, indicate which direction it would move if (1) D₁ increases, (2) K_e increases, and (3) g increases.

Transcribed Image Text:

P = D5 K -8 Ke g