The current share price of Blueberry plc is 205p. It recently reported earnings per share of 14p and has a policy of paying out 50 per cent of earnings in dividends each year. The earnings history of the firm is as follows:
Last reported ..................... 14p
One year ago ..................... 13p
Two years ago ..................... 12p
Three years ago .................. 11p
Four years ago ..................... 10p
Five years ago ..................... 9p
The rate of growth in earnings and dividends shown in the past is expected to continue into the future.
The risk-free rate of return is 6.5 per cent and the risk premium on the average share has been 5 per cent for decades. Blueberry is in a higher systematic risk class than the average share and therefore the risk premium needs to be adjusted by a beta factor of 1.2.
Required
a. Calculate the historical price-earnings ratio.
b. Calculate the future growth rate of dividends and earnings.
c. Calculate the required rate of return on a share of this risk class.
d. Use the more complete PER model to decide whether the shares at 205p are over- or under-priced.