Newman Manufacturing is considering a cash purchase of the shares of Grips Tools
ID: 2763346 • Letter: N
Question
Newman Manufacturing is considering a cash purchase of the shares of Grips Tools. During the year just completed, Grips earned $4.25 per share and paid cash dividends of $2.55 per share. Grips' earnings and dividends are expected to grow at 25% per year for the next three years, after which they are expected to grow at 10% per year to infinity. What is the maximum price per share Newman should pay for Grips if it has a required return of 15% on investments with risk characteristics similar to those of Grips?Explanation / Answer
D0 =$2.55
D1 =$3.1875
D2 =$3.9844
D3 =$4.9805
D4 = $5.4786 (and going forward at a constant rate of 10% till infinity)
PV = $3.1875/1.15 + $3.9844/1.15^2 + $4.9805/1.15^3
= $9.0593
PV3 = Div4 / (re -g) = $5.4786/ (0.15 - 0.10) = $109.572. Find present value of $109.572 in year zero = $109.572/1.15^3 = $72.0454
$9.0593+$72.0454= $81.1047 is the maximum price that Newman should pay for Grips.