Background of the Case
Earning per share (EPS) is known to be a key metric used to determine a shareholder’s portion of the company’s profit. It is widely used to assess a company’s performance, and high values of these indicators usually make a stock more attractive to potential investors (Earnings Per Share (EPS)). In this case, there is a stock price of which is €500, EPS is €33.3, payout ratio equals 25%, and projected EPS growth equals 15% (Bond Yield and Return; Vernimmen et al., 2014, p. 403). It is possible to discuss what value EPS should have to obtain 12% return on the investment and what share is worth at this P/E ratio.
Discussion of the Case
The key point of this case if the price to earnings (P/E) ratio. This indicator enables to relate a share price to earnings per share and, thus, to determine the return on the investment (What is the Price Earnings Ratio?). Considering the value of EPS (33,3), the ratio that shows the portion of EPS paid (25%), and adding annual EPS growth (15%) to the formula of cash flows, it is possible to see that the value of the share in the year 3 equals €665.46. The cash flow of the year 3 is 12.66, which divided by the payout ratio gives the value of 50.65 of net EPS. The calculations also reflect the discounted cash flows. Considering that the discount rate equals 12%, discounted value per share equals €473.66 (What is the Price Earnings Ratio?). By dividing the share value by net EPS, it is possible to obtain a P/E ratio that equals 13.14. For net earnings per share to be equal 12 percent of the cost of the share (€60), EPS should be equal to €39,5 approximately. The value of share changed, as according to the formula Stock value = P/E * EPS, in the event P/E ratio is still 13.14, the value of share = 13.14 * 60.0 = €788.4.
References
Earnings Per Share (EPS). (n.d.). Web.
Vernimmen, P., Quiry, P., Dallocchio, M., & Le Fur, Y. (2014). Corporate Finance: Theory and Practice (5th ed.). John Wiley & Sons, Incorporated
What is the Price Earnings Ratio? (n.d.). Web.