Question

Simpkins Corporation does not pay any dividends because it is expanding rapidly and needs to retain all of its earnings. However, investors expect Simpkins to begin paying dividends, with the first dividend of $0.75 coming 3 years from today. The dividend should grow rapidly - at a rate of 70% per year - during Years 4 and 5. After Year 5, the company should grow at a constant rate of 7% per year. If the required return on the stock is 18%, what is the value of the stock today (assume the market is in equilibrium with the required return equal to the expected return)? Round your answer to the nearest cent. Do not round your intermediate computations.

Answer 1

As per dividend discount model, Price of stock is the present value of dividend.
a.	Present value of 5 years dividend
	Year	Dividend	Discount factor @ 18%	Present Value
	3	$    0.750	0.608631	$       0.46
	4	$    1.275	0.515789	$       0.66
	5	$    2.168	0.437109	$       0.95
	Total			$       2.06
b.	Horizon Value of company
	Horizon Value		=	D5*(1+g)/(Ke-g)			Where,
			=	2.168*(1+0.07)/(0.18-0.07)			D5	$    2.168
			=	$    21.09			Ke	18%
							g	7%
c.	Present Value of horizon value
	Present Value		=	Horizon Value x Disount factor
			=	$    21.09	x	0.437109
			=	$       9.22
d.	Present value of all dividend			=	$       2.06	+	$       9.22
				=	$    11.28
Thus,
	Current Price of Stock is			$    11.28