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 $1.00 coming 3 years from today. The dividend should grow rapidly at a rate of 50% per year-during Years 4 and 5; but after Year 5, growth should be a constant 4% per year. If the required return on Computech is 15%, what is the value of the stock today? Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

Price of stock today is present value of future cash flows that is present value of dividends and price of stock in year 5

Dividend year 3(D3)= $1.00

D4= D3*(1+g)

=1*(1+50%)= 1.50

D5= 1.50*(1+50%)= 2.25

Thereafter Constant Growth starts (g)= 4%

Required Return (ke)= 15%

Price of stock in year 5 (P5) as per Constant Growth model = D5*(1+g)/(ke-g)

=2.25*(1+4%)/(15%-4%)

=21.27272727

Price of stock today (P0) = (D3/(1+ke)^3) + (D4/(1+ke)^4)+((D5+P5)/(1+ke)^5)

=(1/(1+15%)^3) +(1.5/(1+15%)^4)+((2.25+21.27272727)/(1+15%)^5)

=13.21009885

So Value of Stock today is 13.21