Question

Computech Corporation is expanding rapidly and currently needs to retain all of its earnings; hence, it does not pay dividends. However, investors expect Computech to begin paying dividends, beginning with a dividend of $1.75 coming 3 years from today. The dividend should grow rapidly - at a rate of 19% per year - during Years 4 and 5; but after Year 5, growth should be a constant 6% per year.

If the required return on Computech is 18%, what is the value of the stock today? Round your answer to the nearest cent. Do not round your intermediate calculations.

Answer 1

D3=1.75

D4=(1.75*1.19)=2.0825

D5=(2.0825*1.19)=2.478175

Value after year 5=(D5*Growth rate)/(Required return-Growth rate)

=(2.478175*1.06)/(0.18-0.06)

=21.8905458

Hence current price=Future dividend and value*Present value of discounting factor(rate%,time period)

=1.75/1.18^3+2.0825/1.18^4+2.478175/1.18^5+21.8905458/1.18^5

=$12.79(Approx)