Question

Newman Manufacturing is considering a cash purchase of the stock of Grips Tool. During the year just​ completed, Grips earned ​$3.58 per share and paid cash dividends of ​$1.88 per share ​(​D0=$​1.88). ​Grips' earnings and dividends are expected to grow at ​35% per year for the next three​ years, after which they are expected to grow at ​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?

Answer 1

D1=(1.88*1.35)=2.538

D2=(2.538*1.35)=3.4263

D3=(3.4263*1.35)=4.625505

Value after year 3=(D3*Growth rate)/(Required return-Growth rate)

=(4.625505*1.08)/(0.15-0.08)

=71.3649343

Hence current price=Future dividend and value*Present value of discounting factor(rate%,time period)

=2.538/1.15+3.4263/1.15^2+4.625505/1.15^3+71.3649343/1.15^3

=$54.76(Approx)