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 3.20. It expects zero growth in the next year. In years 2 and​ 3, 4​% growth is​ expected, and in year​ 4, 19​% growth. In year 5 and​ thereafter, growth should be a constant 9​%

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

18​% should pay for Home Place Hotels common​ stock? The maximum price per share that an investor who requires a return of 18​%

should pay for Home Place Hotels common stock is $ _____ (Round to the nearest​ cent.)

Answer 1

Price of Common Stock = [{D0 * (1 + g1)} / (1 + r)] + [{D0 * (1 + g1) * (1 + g2)} / (1 + r)²] + [{D0 * (1 + g1) * (1 + g2)²} / (1 + r)³] + [{D0 * (1 + g1) * (1 + g2)² * (1 + g3)} / (1 + r)⁴] + [{D0 * (1 + g1) * (1 + g2)² * * (1 + g3) * (1 + gC)} / {(r - gC) * (1 + r)⁴}]

= [{$3.20 * (1 + 0)} / (1 + 0.18)] + [{$3.20 * (1 + 0) * (1 + 0.04)} / (1 + 0.18)²] + [{$3.20 * (1 + 0) * (1 + 0.04)²} / (1 + 0.18)³] + [{$3.20 * (1 + 0) * (1 + 0.04)² * (1 + 0.19)} / (1 + 0.18)⁴] + [{$3.20 * (1 + 0) * (1 + 0.04)² * (1 + 0.19) * (1 + 0.09)} / {(0.18 - 0.09) * (1 + 0.18)⁴}]

= $2.71 + $2.39 + $2.11 + $2.12 + $25.73 = $35.06