Newman manufacturing is considering a cash purchase of the stock of Grips Tool.
ID: 2739412 • Letter: N
Question
Newman manufacturing is considering a cash purchase of the stock of Grips Tool. During the year just completed, Grips earned $4.26 per share and paid cash dividends of $2.56 per share (D0=$2.56). Grips' earnings and dividends are expected to grow at 40% per year for the next 3 years, after which they are expected to grow 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 16% on investments with risk characteristics similar to those of Grips?
Explanation / Answer
Calculation of Share price based on dividends based:
Share value = Share annual dividend / (Required return – Dividend growth rate)
= $2.56 / (0.16 -0.08)
= $32
Therefore, the share price is $32