3.Fred Tibbits has made a detailed study of the denim clothing industry. He’s particularly interested in a company called Denhart Fashions that makes stylish denim apparel for children and teenagers. Fred has done a forecast of Denhart’s earnings and looked at its dividend payment record. He’s come to the conclusion that the firm will pay a dividend of $5.00 for the next two years followed by a year at $6.50. Fred’s investment plan is to buy Denhart now, hold it for three years and then sell. He thinks the price will be about $75 when he sells. What is the most Fred should be willing to pay for a share of Denhart if he can earn 10% on investments of similar risk?
Answer : $ 69.91 is the most Fred should be willing to pay for a share of Denhart if he can earn 10% on investments of similar risk
Working Notes for the above answer is as follow
We have provided with the information that ,
firm will pay a dividend of $5.00 for the next two years followed by a year at $6.50.
So year 1 Dividend is = $ 5
year 2 Dividend is = $ 5
year 3 Dividend is = $ 6.5
And Fred’s investment plan is to buy Denhart now, hold it for three years and then sell. He thinks the price will be about $75 when he sells
So year three cash flow = $ 75+$ 6.50
=$ 81.50
Let us calculate prasent value as follow
| Year | Cash flow | PV Factor @ 10% |
Prasent Value |
| 1 | 5 | 0.90909 | 4.545455 |
| 2 | 5 | 0.82645 | 4.132231 |
| 3 | 81.5 | 0.75131 | 61.23216 |
| 69.90984 |
