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 $1.88 per share (D0equals$ 1.88 ). Grips' earnings and dividends are expected to grow at 25 % 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 12 % on investments with risk characteristics similar to those of Grips?

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24 July, 09:44

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 $1.88 per share (D0equals$ 1.88 ). Grips' earnings and dividends are expected to grow at 25 % 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 12 % on investments with risk characteristics similar to those of Grips?

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Dillon · Answer 1

D0 = $1.88

D1 = 1.88*1.25 = $2.35

D2 = 2.35*1.25 = $2.94

D3 = 2.94*1.25 = $3.67

PV of Dividends:

r = 12%

1 / (1.12) = 0.89

PV of D1 = 2.35/0.89 = $2.64

PV of D2 = 2.94/0.797 = $3.69

PV of D3 = 3.67/0.71 = $5.17

Total PV = $11.5

Value after year 3:

(D3*Growth rate) / (Required rate - growth rate) = $3.67*1.06 / (0.12-0.06) = $64.8

Pv of 64.8 is 64.8 / (1.12) ^3 = $46.3

So, the maximum price per share is 11.5+46.3 = $57.8