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 $1.50 coming 3 years from today. The dividend should grow rapidly - at a rate of 75% per year - during Years 4 and 5. After Year 5, the company should grow at a constant rate of 10% 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

Answer:-

There is no talk for Dividend for year 1 and 2.

So, Dividend for year 3 (D3) = $1.50

Dividend for year 4 (D4) = $1.50 x (1 + 0.75) = $1.50 x 1.75 = $2.625

Dividend for year 5 (D5) = $2.625 x (1 + 0.75) = $4.59375

Value after year 5= (D5 x Growth rate) / (Required return - Growth rate)

= ( $4.59375 x 1.10) / ( 0.16 - 0.10 )

= $84.21875

Hence current price = Future dividend and value x Present value of discounting factor(rate%,time period)

= 1.50 / (1.16)³ + 2.625 /(1.16)⁴ + 4.59375 /(1.16)⁵ + 84.21875 /(1.16)⁵

=$44.6955

or

= $44.70 (Approx).

So, Value of the stock today is $44.70