Home Place Hotels, Inc., is entering into a 3-year remodeling and expansion proj

Question

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 $2.80. It expects zero growth in the next year In years 2 and 3, 4% growth is expected, and in year 4, 19% growth. In year 5 and thereafter; growth should be a constant 12% 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?

Explanation / Answer

Calculate present value of dividend upto year 4 (a) Years 0 1 2 3 4 Dividend 2.8           2.80           2.91           3.03           3.60 Discount factor(17%) 1         0.855         0.731         0.534         0.534 Present value           2.39           2.13           1.62           1.92 Total           8.06 Value of dividend on and after 4th year = 8.06*(1+.12)/(.17-.12) =            181 Present value of above dividend, (b) = 181 x 0.534 = 97 Total Present value of dividend (a)+(b) =      104.71

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