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4-24: Zenith Propulsion, Inc
4-24: Zenith Propulsion, Inc. is expected to pay a dividend next year of $2.45 per share. Investors think that Zenith will continue to increase its dividend by 5% each year for the foreseeable future.
a. If the required rate of return on Zenith stock is 13%, then what is Zenith's stock price?
b. Investors expect Zenith to pay out 50% of its earnings as dividends. What is Zenith's price/earnings ratio? (Here P/E is defined as current price dividend by next year's earnings)
Expert Solution
a. Computation of Zenith's Stock Price:
Current Stock Price = Dividend for Next Year/(Required Rate of Return - Growth Rate)
= $2.45/(13%-5%)
= $2.45/8%
Current Stock Price = $30.63
So, Zenith's Stock Price is $30.63
b. Computation of Zenith's Price/Earnings Ratio:
Price/Earnings Ratio = Current Stock Price / Next Year's Earnings
= $30.63/ ($2.45*2)
= $30.63 / $4.90
Price/Earnings Ratio = 6.25
So, Zenith's Price/Earnings Ratio is 6.25
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