Model 5 Pre HW

dividend growth   rate, g 2. This value is found by applying the Gordon model to the dividends expected from year 4 to   infinity, as shown   below: P 3 = D 4 rs − g 2 =( D 3 x 1 + g 2 rs − g 2 ) The dividend amount at the end of year 4 is computed   as: D 4 = D 3 x ( 1 + g 2 ) 1 = $ 1.22 x ( 1 + 0.04 ) 1 = $ 1.27 Therefore, the stock price at the end of the initial growth period can be estimated with the Gordon   model: P 3 = D 4 rs − g 2 = $ 1.27 0.08 − 0.04 = $ 31.75 The present value of P 3 would represent the value today of all dividends that are expected to be received from year 4 to infinity. This value can be calculated using the following   formula: Present value, P0, of the stock price P3, at the end of the initial growth period P 3 ( 1 + rs ) 3 = $ 31.75 ( 1 + 0.08 ) 3 = $ 25.20 Add the present value components found in Steps 2 and 3 to find the value of the   stock, P 0: P 0 = D 1 ( 1 + rs ) 1 + D 2 ( 1 + rs ) 2 + D 3 ( 1 + rs ) 3 + P 3 ( 1 + rs ) 3 Therefore, P0 = $0.85 + $0.91 + $0.97 + $25.20 + $2.73 + $25.20 = $27.93 The maximum price per share that Newman should pay for Grips is $27.93