Dominik Corporation is a fast growing company. They were the first to the market

Question

Dominik Corporation is a fast growing company. They were the first to the market with state- of-the-art voice identification software. Earnings per share for 2005 were $2.08 and book value per share at the beginning of 2005 was $9.55. Dominik does not pay dividends nor is it expected to do so in the foreseeable future. Dominik's cost of equity is 12%.

Analysts predict that earnings for 2006 and 2007 will be $3.22 and $3.90, respectively, and that earnings will grow at 19% per year for the following three years (2008-2010). The stock is currently trading at $35 per share, and analysts have set a target price of $50 by the end of 2006.

Assuming that the analysts earnings forecasts for the next five years are correct, and assuming that after the end of the next five years the competition will have driven Dominik's abnormal returns down to zero, what would your target price be for the end of 2006? What will the price to book value and price-earnings ratios be at the end of 2006?

Explanation / Answer

Year (end) Earnings PV Factor@ 12% PV of earnings 2006 3.22 1                           3.22 2007 3.9 0.892857143                           3.48 2008 4.641 0.797193878                           3.70 2009 5.52279 0.711780248                           3.93 2010 6.57212 0.635518078                           4.18 PV of Earnings at the end of year 2006                        18.51 The Price of the share at the end of the year 2006 = Book Value at the end of year 2006+ PV of earnings = (9.55+2.08+3.22)+ 18.51 = $33.36 Price to Book Value = 33.36/(9.55+2.08+3.22) = 2.25 PE ratio = Market price/ Earnings per share = 33.36/3.22 = 10.36

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