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 30% per year - during Years 4 and 5; but after Year 5, growth should be a constant 7% per year. The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the question below. Open spreadsheet If the required return on Computech is 14%, what is the value of the stock today? Round your answer to the nearest cent. Do not round your intermediate calculations.

Answer 1

Step-1, Dividend per share for Years 3,4 and 5

Dividend in Year 3 (D3) = $1.75 per share

Dividend in Year 4 (D4) = $2.2750 [$1.75 x 130%]

Dividend in Year 5 (D5) = $2.9575 [$2.2750 x 130%]

Step-2, Calculation of Stock Price in Year 5 (P5)

Stock Price in Year 5 = D5(1 + g) / (Ke – g)

= $2.9575(1 + 0.07) / (0.14 – 0.07)

= $3.1645 / 0.07

= $45.21

Step-3, Value of the stock today

The value of the stock today is the aggregate of present value of future dividends and Stock Price in Year 5

Year	Cash flow ($)	Present Value Factor (PVF) at 14.00%	Present Value of cash flows ($) [Cash flows x PVF]
3	1.7500	0.67497	1.18
4	2.2750	0.59208	1.35
5	2.9575	0.51937	1.54
5	45.21	0.51937	23.48
TOTAL	27.54

Therefore, the value of the stock today is $27.54

NOTE

The Formula for calculating the Present Value Factor is [1/(1 + r)ⁿ], Where “r” is the Discount/Interest Rate and “n” is the number of years.