Shares in Brothers Grimm, Inc. , manufacturers of gingerbread houses, are expect

Question

Shares in Brothers Grimm, Inc. , manufacturers of gingerbread houses, are expected to pay a dividend of $5. 00 in one year and to sell for $100 per share at that time. How mu ch should you be willing to pay today per share of Grimm: If the rate of interest is S percent and you believe that investing in Grimm carries no risk? If the safe rate of interest is 10 percent and you believe that investing in Grimm carries no risk? If the safe rate of interest is 5 percent but your risk premium is 3 percent? Repeat parts (a) to (c), assuming that Grimm is not expected to pay a dividend but the expected price is unchanged.

Explanation / Answer

a)Price of share today = Present value of future cash flows = (5+100)/1.05 = $100.0 b)Price of share today at 10% interest rate = (5+100)/1.1 = $95.45 c)Interest rate = safe rate + risk premium = 5+ 3 = 8% Price of share today at 8% interest rate = (5+100)/1.08 = $97.22 d)Price of share today at 5% = Present value of future cash flows = (100)/1.05 = $95.24 Price of share today at 10% interest rate = (100)/1.1 = $90.91 Interest rate = safe rate + risk premium = 5+ 3 = 8% Price of share today at 8% interest rate = (100)/1.08 = $92.59

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