3.Fred Tibbits has made a detailed study of the denim clothing industry. He\'s p

Question

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?

Explanation / Answer

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

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