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.)

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