Question

Nonconstant Growth Stock Valuation

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 $1.00 coming 3 years from today. The dividend should grow rapidly - at a rate of 55% 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 16%, 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

Price of share can be computed by discouting cash flow (Dividend) at 16% rate of return .
Given that -
Dividend at year 3 =			1
Dividend at year 4 = 1*155%			1.55
Dividend at year 5 =1.55*155%			2.4025
After 5th year dividend growth rate = 7% forever
Terminal value at the end of 5th year = Expected dividend in year 6/(required rate - growth rate)
			=2.4025/(16%-7%)
			26.69
Computation of present value of cash flow
	i	ii	iii=i+ii	iv	v=iii*iv
year	Cash flow	Terminal value	total cash flow	PVIF @ 16%	present value
1	0		0	0.862069	-
2	0		0	0.743163	-
3	1		1	0.640658	0.64
4	1.55		1.55	0.552291	0.86
5	2.4025	26.69	29.09694	0.476113	13.85
Price today =					15.35