Question

Home Place​ Hotels, Inc., is entering into a​ 3-year remodeling and expansion project. The construction will have a limiting effect on earnings during that​ time, but when it is​ complete, it should allow the company to enjoy much improved growth in earnings and dividends. Last​ year, the company paid a dividend of

​$4.104.10.

It expects zero growth in the next year. In years 2 and​ 3,

55​%

growth is​ expected, and in year​ 4,

1717​%

growth. In year 5 and​ thereafter, growth should be a constant

1111​%

per year. What is the maximum price per share that an investor who requires a return of

1414​%

should pay for Home Place Hotels common​ stock?

Answer 1

Year 1 dividend = 4.1

Year 2 dividend = 4.1 * 1.05 = 4.305

Year 3 dividend = 4.305 * 1.05 = 4.52025

Year 4 dividend = 4.52025 * 1.17 = 5.28869

Year 5 dividend = 5.28869 * 1.11 = 5.87045

value at year 4 = D5 / required rate - growth rate

value at year 4 = 5.87045 / 0.14 - 0.11

value at year 4 = 5.87045 / 0.03

value at year 4 = 195.68167

Value of stock = 4.1 / (1 + 0.14)¹ + 4.305 / (1 + 0.14)² + 4.52025 / (1 + 0.14)³ + 5.28869 / (1 + 0.14)⁴ + 195.68167 / (1 + 0.14)⁴

Value of stock = $128.95