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Stock Valuation and PE [LO2] Fly Away, Inc
Stock Valuation and PE [LO2] Fly Away, Inc., has balance sheet equity of $7.3 million. At the same time, the income statement shows net income of $875,000. The company paid dividends of $345,000 and has 125,000 shares of stock outstanding. If the benchmark PE ratio is 16, what is the target stock price in one year?
Expert Solution
Answer:
Compute return on earnings (ROE)
ROE = Net income / Equity
= $875,000 / $7,300,000
= 0.1199 or 11.99%
Compute dividend payout ratio
Dividend payout ratio = Dividends / Net income
= $345,000 / $875,000
= 0.3942 or 39.42%
Compute retention ratio
Retention ratio = 1 - Dividend payout ratio
= 1 - 0.3942
= 0.6058 or 60.58%
Compute sustainable growth rate
Sustainable growth rate = ROE * Retention ratio / 1 - (ROE * Retention ratio)
= 0.1199*0.6058 / 1 - (0.1199 * 0.6058)
= 0.0726 / 0.9274
= 0.0783 or 7.83%
Compute current earnings per share value EPS0.
EPS0 = Net income / Shares outstanding
= $875,000 / 125,000 shares
= $7.00
Compute next year earnings per share, EPS1
EPS1 = EPS0 * (1 + g)
= $7.00 * (1+0.0783)
= $7.00 * 1.0783
= $7.55
Compute target stock price P1
P1 = (Benchmark P/E ratio * EPS1)
= 16*$7.55
= $120.80
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