Question

Common stock valuelong dash—Variabl growth Newman Manufacturing is considering a cash purchase of the stock of Grips Tool. During the year just​ completed, Grips earned ​$4.29 per share and paid cash dividends of ​$2.59 per share ​(D0=$ 2.59​). Grips' earnings and dividends are expected to grow at 20​% per year for the next 3​ years, after which they are expected to grow 6​% per year to infinity. What is the maximum price per share that Newman should pay for Grips if it has a required return of 13​% on investments with risk characteristics similar to those of​ Grips?  

The maximum price per share that Newman should pay for Grips is $_____   ​(Round to the nearest​ cent.)

Answer 1

The price is computed as shown below:

= Dividend in year 1 / (1 + required rate of return)¹ + Dividend in year 2 / (1 + required rate of return)² + Dividend in year 3 / (1 + required rate of return)³ + 1 / (1 + required rate of return)³ [ ( Dividend in year 3 (1 + growth rate) / ( required rate of return - growth rate) ]

= ($ 2.59 x 1.20) / 1.13 + ($ 2.59 x 1.20²) / 1.13² + ($ 2.59 x 1.20³) / 1.13³ + 1 / 1.13³ x [ ($ 2.59 x 1.20³ x 1.06) ] / (0.13 - 0.06) ]

= $ 3.108 / 1.13 + $ 3.7296 / 1.13² + $ 4.47552 / 1.13³ + 1 / 1.13³ x [ ($ 67.77216) ]

= $ 3.108 / 1.13 + $ 3.7296 / 1.13² + $ 72.24768 / 1.13³

= $ 55.74 Approximately

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