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 $0.75 coming 3 years from today. The dividend should grow rapidly-at a rate of 17% per year-during Years 4 and 5; but after Year 5, growth should be a constant 5% 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

Solution:
	The value of the stock today = $4.98
Working Notes:
	Using DDM dividend discount model
	P0= D3/(1+r)^3+ D4/(1+r)^4+D5/(1+r)^5 + P5/(1+r)^5
	where r = required rate of return =18%
	D3 =$0.75
	D4 = D3 x (1+g) = $0.75 x (1+.17) = $0.8775
	D5 = D4 x (1+g) = $0.8775 x (1+.17) =$1.026675
	D6 = D5 x (1+g) = $1.026675 x (1+.05) = $1.07800875
	Using for constant growth model (DVM) for valuing dividends from year 5 to infinity
	P5 = D6 / (r - g)
	= $1.07800875/( .18 - 0.05)
	=$1.07800875/0.13
	= $8.292375
	P0= D3/(1+r)^3+ D4/(1+r)^4+D5/(1+r)^5 + P5/(1+r)^5
	P0= $0.75/(1+.18)^3+ 0.8775/(1+0.18)^4+1.026675/(1+0.18)^5 + 8.292375/(1+0.18)^5
	P0= 4.98252
	P0= $4.98
Please feel free to ask if anything about above solution in comment section of the question.