Question

Common stock value long dash Variable growth Newman Manufacturing is considering a cash purchase of the stock of Grips Tool. During the year just​ completed, Grips earned ​$4.13 per share and paid cash dividends of ​$2.43 per share ​(D0 Equals$ 2.43​). ​ Grips' earnings and dividends are expected to grow at 25​% per year for the next 3​ years, after which they are expected to grow 8​% per year to infinity. What is the maximum price per share that Newman should pay for Grips if it has a required return of 15​% on investments with risk characteristics similar to those of​ Grips?The maximum price per share that Newman should pay for Grips is $.

Answer 1

$56.78

Step-by-step explanation:

Find dividend per year;

D1 = D0 (1+g) = 2.43 (1.25) = 3.0375

D2 = 3.0375(1.25) = 3.7969

D3 = 3.7969 (1.25) = 4.7461

D4 = 4.7461 (1.08) = 5.1258

Next, find the present values (PVs) of each dividend at 15% required return;

PV(D1) = 3.0375/ 1.15 = 2.6413

PV(D2) = 3.7969/ 1.15² = 2.8710

PV(D1) = 4.7461 / 1.15³ = 3.1206

PV of terminal cashflow (D4 onwards) =
`((5.1258)/(0.15-0.08) )/(1.15^(3) )` = 48.1471

Sum up the PVs to get the price per share;

= 2.6413 + 2.8710 + 3.1206 + 48.1471

= 56.78

Therefore, price = $56.78