Question

Common stock value - Variable growth Newman Manufacturing is considering a cash purchase of the stock of Grips Tool. During the year just completed, Grips earned $3.81 per share and paid cas dividends of $2.11 per share (D₀ =$2.11). Grips' earnings and dividends are expected to grow at 20% per year for the next 3 years, after which they are expected to grow 9% per year to infinity. What is th maximum price per share that Newman should pay for Grips if it has a required return of 16% on investments with risk characteristics similar to those of Grips? The maximum price per share that Newman should pay for Grips is 9 (Round to the nearest cent.)

Answer 1

To calculate the maximum price per share that Newman should pay for Grips, we can use the Gordon Growth Model. The maximum price per share is $25.32.

Step-by-step explanation:

To calculate the maximum price per share that Newman should pay for Grips, we can use the Gordon Growth Model.

The formula for the Gordon Growth Model is:

P0 = D1 / (R - g)

where:

• P0 is the maximum price per share that Newman should pay
• D1 is the dividend expected to be paid in the next year
• R is the required return
• g is the growth rate

In this case, D1 can be calculated by multiplying the current dividend per share (D₀) by the growth rate (20%).

Substituting the values into the formula:

P0 = $2.11 * 1.2 / (0.16 - 0.2) = $25.32

Therefore, the maximum price per share that Newman should pay for Grips is $25.32.