ESSENTIALS CORPORATE FINANCE + CNCT A.
ESSENTIALS CORPORATE FINANCE + CNCT A.
9th Edition
ISBN: 9781259968723
Author: Ross
Publisher: MCG CUSTOM
Question
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Chapter 7, Problem 28QP
Summary Introduction

To determine: The high and low target stock prices over the next year.

Introduction:

Target stock price is a price in which the investor wants to exit from the current position to attain maximum earnings.

Expert Solution & Answer
Check Mark

Answer to Problem 28QP

The high target stock prices over the next year are $76.95.

The low target stock prices over the next year are $60.79.

Explanation of Solution

Given information:

The high price of Year 1, Year 2, Year 3, and Year 4 is $48.60, $57.34, $69.46, and $74.85 respectively. The low price of Year 1, Year 2, Year 3, and Year 4 is $37.25, $42.18, $55.85, and $63.18 respectively. The earnings per share of Year 1, Year 2, Year 3, and Year 4 are $2.35, $2.48, $2.63, and $2.95. The projected earnings growth rate for next year is 9%.

Formulae:

The formula to calculate next year’s earnings per share:

EPS1=EPSo(1+g)

Where,

EPS1refers to the earnings per share of next year,

EPSorefers to the current year’s earnings per share,

g refers to the expected growth rate.

The formula to calculate high or low price to earnings ratio:

High or low price to earnings ratio=High or low price of stock of the yearEarnings per share of the year

The formula to determine average high or low price to earnings:

Average high or low price to earnings ratio=Sum of each year's high or low price to earnings ratioTotal number of years

The formula to calculate the price of a share of stock:

P1=Benchmark price to earnings ratio ×EPS1

Where,

EPS1 refers to the earnings per share of next year,

P1 refers to the price of stock per share.

Note:

The current stock price is often called as high or low target stock prices over the next year.

Compute the next year’s earnings per share:

EPS1=EPSo(1+g)=$2.95×(1+9100)=$2.95×1.09=$3.22

Hence, the next year’s earnings per share are $3.22.

Compute the high price to earnings ratio of Year 1:

High price to earnings ratio of Year 1=High price of stock of Year 1 Earnings per share of Year 1=$48.60$2.35=$20.68

Hence, the high price to earnings ratio of Year 1 is $20.68.

Compute the high price to earnings ratio of Year 2:

High price to earnings ratio of Year 2=High price of stock of Year 2 Earnings per share of Year 2=$57.34$2.48=$23.12

Hence, the high price to earnings ratio of Year 2 is $23.12.

Compute the high price to earnings ratio of Year 3:

High price to earnings ratio of Year 3=High price of stock of Year 3 Earnings per share of Year 3=$69.46$2.63=$26.41

Hence, the high price to earnings ratio of Year 3 is $26.41.

Compute the high price to earnings ratio of Year 4:

High price to earnings ratio of Year 4=High price of stock of Year 4 Earnings per share of Year 4=$74.85$2.95=$25.37

Hence, the high price to earnings ratio of Year 4 is $25.37.

Compute the average high price to earnings:

Average high price to earnings ratio=Sum of each year's high price to earnings ratioTotal number of years=$20.68+$23.12+$26.41+$25.374=$95.584=$23.90

Hence, the average high price to earnings ratio is $23.90.

Compute the high price of a share of stock:

P1=Benchmark price to earnings ratio×EPS1=$23.90×$3.22=$76.95

Hence, high price of a share of stock is $76.95.

Compute the low price to earnings ratio of Year 1:

Low price to earnings ratio of Year 1=Low price of stock of Year 1 Earnings per share of Year 1=$37.25$2.35=$15.85

Hence, the low price to earnings ratio of Year 1 is $15.85.

Compute the low price to earnings ratio of Year 2:

Low price to earnings ratio of Year 2=Low price of stock of Year 2 Earnings per share of Year 2=$42.18$2.48=$17.01

Hence, the low price to earnings ratio of Year 2 is $17.01.

Compute the low price to earnings ratio of Year 3:

Low price to earnings ratio of Year 3=Low price of stock of Year 3 Earnings per share of Year 3=$55.85$2.63=$21.24

Hence, the low price to earnings ratio of Year 3 is $21.24.

Compute the low price to earnings ratio of Year 4:

Low price to earnings ratio of Year 4=Low price of stock of Year 4 Earnings per share of Year 4=$63.18$2.95=$21.42

Hence, the low price to earnings ratio of Year 4 is $21.42.

Compute the average low price to earnings:

Average low price to earnings ratio=Sum of each year's low price to earnings ratioTotal number of years=$15.85+$17.01+$21.24+$21.424=$75.524=$18.88

Hence, the average low price to earnings ratio is $18.88.

Compute the low target price (price of a share of stock):

P1=Benchmark price to earnings ratio×EPS1=$18.88×$3.22=$60.79

Hence, the low price of a share of stock is $60.79.

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Chapter 7 Solutions

ESSENTIALS CORPORATE FINANCE + CNCT A.

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