Question

Common stock valuelong dashVariable growth Personal Finance Problem Home Place​ Hotels, Inc., is entering into a​ 3-year remodeling and expansion project. The construction will have a limiting effect on earnings during that​ time, but when it is​ complete, it should allow the company to enjoy much improved growth in earnings and dividends. Last​ year, the company paid a dividend of ​$3.70. It expects zero growth in the next year. In years 2 and​ 3, 6​% growth is​ expected, and in year​ 4, 18​% growth. In year 5 and​ thereafter, growth should be a constant 9​% per year. What is the maximum price per share that an investor who requires a return of 17​% should pay for Home Place Hotels common​ stock? The maximum price per share that an investor who requires a return of 17​% should pay for Home Place Hotels common stock is ​$ nothing. ​ (Round to the nearest​ cent.)

Answer 1

Answer:

Maximum Price per Share = $42.60

Explanation:

Using dividend discount model, we can calculate the price per share or the intrinsic value per share which is the fair value of a share based on the future cash flows expected from it by the investors.

We first calculate the dividends and then discount them by the required rate of return of 17%.

We start from D1 which is expected dividend next year and then calculate future dividends applying the growth rate and when the dividend growth becomes constant, we calculate the terminal value.

The dividends are,

• D1 = 3.7                                           = $3.7    

• D2 = 3.7*(1.06)                                = $3.922

• D3 = 3.7*(1.06^2)                           = $4.15732

• D4 = 3.7*(1.06^2) * (1.18)                 = $4.9056376

• D5  = 3.7*(1.06^2) * (1.18) * (1.09)   = $5.347144984

To calculate Price today or the fair value today, we discount these by required rate of return and calculate the terminal value for year 5 where growth becomes constant.

P = 3.7/1.17 + 3.922/(1.17)^2 + 4.15732/(1.17)^3 + 4.9056376/(1.17)^4 + 5.347144984 / 0.17 - 0.09

P = $42.60486328 rounded off to $42.60

Thus, an investor requiring 17% return will pay a maximum of $42.60 / share