Newman manufacturing is considering a cash purchase of the stock of Grips Tool.
ID: 2781627 • Letter: N
Question
Newman manufacturing is considering a cash purchase of the stock of Grips Tool. During the year just completed, Grips earned $3.32 per share and paid cash dividends of $1.62 per share (D0equals=$ 1.62). Grips' earnings and dividends are expected to grow at 30% 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 14% on investments with risk characteristics similar to those of Grips?
Explanation / Answer
Dividend for year 1=(1.62*1.3)=2.106
Dividend for year 2=(2.106*1.3)=2.7378
Dividend for year 3=(2.7378*1.3)=3.55914
Value after year 3=(Dividend for year 3*Growth rate)/(required return-growth rate)
=(3.55914*1.08)/(0.14-0.08)=$64.067452
Current value=Future dividends*Present value of discounting factor(14%,time period)
=2.106/1.14+2.7378/1.14^2+3.55914/1.14^3+$64.067452/1.14^3
which is equal to
=$49.60(Approx).