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.

P0 = [D1 ÷ (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. D1 = [($132) (0.64] = $84.48

 

8. R = RF + MRP = 0.025 + 0.06 = 0.085   

 

9. P0 = D1 ÷ (R – G) 

10. P0 = $84.48 ÷ (0.085 – 0.04) = $1,877 

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Introduction to Financial Analysis Copyright © 2022 by Kenneth S. Bigel is licensed under a Creative Commons Attribution 4.0 International License, except where otherwise noted.

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