Question

Asked Nov 21, 2019

72 views

Newman Manufacturing is considering a cash purchase of the stock of Grips Tool. During the year just completed, Grips earned

$3.95

per share and paid cash dividends of

$2.25

per share

(D0equals=$ 2.25).

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

11%

on investments with risk characteristics similar to those of Grips?

Step 1

It is given that,

Growth rate for first three year is 25%.

Growth rate after three year is 6%.

Last paid dividend is $2.25 per share.

Required rate of return is 11%.

The below expression can be used to calculate present value for first three dividend payments:

Step 2

Substitute $2.25 for *d*, 25% for *g* and 11% for *i* in the above formula,

Step 3

The below expression can be used to calculate the present value of ...

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