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 $3.40. It expects zero-growth in the next year. In years 2 and 3, 5% growth is expected, and in year 4, 15% growth. In year 5 and thereafter, growth should be constant 10% per year. What is the maximum price per share that an investor who requires a return of 14% should pay for Home Place Hotels common stock?

Answer 1

To calculate the formula used is

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

= [{$3.40 * (1 + 0)} / (1 + 0.14)] = $ 2.98

+ [{$3.40 * (1 + 0) * (1 + 0.05)} / (1 + 0.14)²] = $2.74

+ [{$3.40 * (1 + 0) * (1 + 0.05)²} / (1 + 0.14)³] = $2.53

+ [{$3.40 * (1 + 0) * (1 + 0.05)² * (1 + 0.15)} / (1 + 0.14)⁴] = $2.55

+ [{$3.40 * (1 + 0) * (1 + 0.05)² * (1 + 0.15) * (1 + 0.1)} / {(0.14 - 0.10) * (1 + 0.14)⁴}] = $70.16

= $ 2.98 + $2.74 + $2.53 + $2.55 + $ 70.16

= $80.96