Question

Common stock valueVariable growth Newman Manufacturing is considering a cash purchase of the stock of Grips Tool. During the year just completed, Grips earned $3.74 per share and paid cash dividends of $2.04 per share (D = $2.04). Grips' earnings and dividends are expected to grow at 35% 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 10% 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

Last Dividend, D0 = $2.04

Growth rate for next 3 years is 35% and a constant growth rate (g) of 6% thereafter

D1 = $2.0400 * 1.35 = $2.7540
D2 = $2.7540 * 1.35 = $3.7179
D3 = $3.7179 * 1.35 = $5.0192
D4 = $5.0192 * 1.06 = $5.3204

Required Return, rs = 10%

P3 = D4 / (rs - g)
P3 = $5.3204 / (0.10 - 0.06)
P3 = $5.3204 / 0.04
P3 = $133.01

P0 = $2.754/1.10 + $3.7179/1.10^2 + $5.0192/1.10^3 + $133.01/1.10^3
P0 = $109.28

The maximum price per share that Newman should pay for Grips is $109.28