P7-12 module 3 answers

# P7-12 module 3 answers - 3 = 3.2744 Sum of PV = 2.7717...

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P 7-12. Common stock value—Variable growth Newman Manufacturing is considering a cash purchase of the stock of Grips Tool. During the year just completed, Grips earned \$4.25 per share and paid cash dividends of \$2.55 per share ( D 0 _\$2.55). Grips’ earnings and dividends are expected to grow at 25% per year for the next 3 years, after which they are expected to grow at 10% per year to infinity. What is the maximum price per share that Newman should pay for Grips if it has a required return of 15% on investments with risk characteristics similar to those of Grips? D1 = \$2.55 (D0) x 1.25 = \$3.1875 ; PV of D1 = 3.1875/(1+.15) 1 = 2.7717 D2 = \$3.1875 x 1.25 = \$3.984 ; PV of D2 = 3.984/(1+.15) 2 = 3.0125 D3= \$3.984 x 1.25 = \$4.98 ; PV of D3 = 4.98/(1+.15)
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Unformatted text preview: 3 = 3.2744 Sum of PV = 2.7717 + 3.0125 + 3.2744 = 9.0586 D4 = \$4.98 x 1.10 (g2) = \$5.478 Value of stock at the end of initial growth period (P 3 ) = D 4 /(r-g 2 )= 5.478/(15% - 10%) \$109.56 Present value (PV) of value of stock at the end the end of year 3 = 109.56/(1+.15) 3 = \$72.04 Current price/value of the stock, P 0 = Sum of PV of dividends in the initial growth period + PV of value of stock at the end of Year 3 \$9.0586 + \$72.04 \$81.0986 (or) \$81.10 Therefore, the maximum price per share that Nerman would pay is equal to \$81.10. common stock value, V S , we must subtract the market value of all of the firm’s debt, V D , and the market value of preferred stock, V P, from V C . V S _ V C _ V D _ V P...
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