14.12: Value Prediction Problem
You are given the following information:
- Next year’s projected EPS for the S&P 500 = $132 per share
- The dividend growth rate has been = 0.04
- The risk-free rate = 0.025 (either the T-Bill or the 10-Year Note, your choice)
- The MRP (Market Risk Premium) = 0.06
- The Return-on-Equity has been = 0.11.
Using the data given, what is the value for the S&P (per share) for next year?
Solution Plan :
Let’s use the DDM!
First, write out the DDM formula first to see what variables you already have and which are missing.
P 0 = [ D 1 ÷ (R – G)]
Then , in no necessary order :
1.G = (ROE) (RR)
2. 0.04 = (0.11) (RR)
3. RR = 0.36
4. PR = 1 – RR
5. PR = 1 – 0.36 = 0.64
6. D = (EPS) (PR)
7. D 1 = [($132) (0.64] = $84.48
8. R = R F + MRP = 0.025 + 0.06 = 0.085
9. P 0 = D 1 ÷ (R – G)
10. P 0 = $84.48 ÷ (0.085 – 0.04) = $1,877