Question

Microtech Corporation is expanding rapidly and currently needs to retain all of its earnings, hence it does not pay dividends. However, investors expect Microtech 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 8% per year. If the required return on Microtech is 15% what is the value of the stock today? Round your answer to two decimal places.

Answer 1

Solution:
	The value of the stock today	$19.89
Working Notes:
	P0 =Current stock price = the value of the stock today =??
	Using DDM
	P0= D3/(1+r)^3 + D4/(1+r)^4 + D5/(1+r)^5+ P5/(1+r)^5
	D3 = $1
	D4 = D3 x (1+g) = $1 x (1+.50) = $1.50
	D5 = D4 x (1+g) = $1.50 x (1+0.50) = $2.25
	Required rate of return of the stock r =15%
	constant growth rate g= 8%
	D6 = D5 x (1+g) = $2.25 x (1+0.08) = $2.43
	Using Gordon growth model :
	P5 = D6 /( r - g)
	= $2.43/( 0.15 - 0.08)
	= $34.7142857142
	P0= D3/(1+r)^3 + D4/(1+r)^4 + D5/(1+r)^5+ P5/(1+r)^5
	P0= $1/(1+0.15)^3 +$1.50/(1+0.15)^4 +$2.25/(1+0.15)^5 + $34.7142857142/(1+0.15)^5
	P0= 19.89292899
	P0= $19.89
Please feel free to ask if anything about above solution in comment section of the question.