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 ​$2.50. It expects zero growth in the next year. In years 2 and​ 3, 4​% growth is​ expected, and in year​ 4, 21​% growth. In year 5 and​ thereafter, growth should be a constant 8​% per year. What is the maximum price per share that an investor who requires a return of 17​% should pay for Home Place Hotels common​ stock?

Answer 1

Required rate of return ( ke) =			17% or	0.17
Growth rate after 4 th years (g)=			8% or	0.08
Dividend Just Paid (D0) =			$2.5000
Add : Growth rate 0			$0.0000
Dividend for Next Year (D1) =			$2.5000
Add : Growth Rate 4%			$0.10
Dividend for Second Year (D2) =			$2.6000
Add : Growth rate 4%			$0.1040
Dividend for Third year (D3) =			$2.7040
Add : Growth 21%			$0.5678
Dividend for 4th Year (D4)			$3.2718
Add : Growth rate 8%			$0.2617
Dividend for 5th year (D5)			$3.5336
Intrinsic Value of stock shall be Present Value of Dividend Received in 4 years and price of stock received at end of 4 years.
Price of stock shall be calculated by Dividend Growth model.
Price at end of 4 years = D5 / (Ke - g)
		3.5336/(0.17 - 0.08)
		$39.2621
Calculation of Intrinsic Value of Stock (P0)
Year				P.V.F. @ 17%		Present value
1	D1	$2.5000		0.854701		$2.1368
2	D2	$2.6000		0.730514		$1.8993
3	D3	$2.7040		0.624371		$1.6883
4	D4	$3.2718		0.53365		$1.7460
4	P4	$39.2621		0.53365		$20.9522
			Total			$28.4226
Intrinsic value of stock (P0)is $ 28.42. So maximum price he will be willing to pay for this stock is $28.42.