Question
In: Finance
Computerplus company already paid $6 dividend per share this year and expects the dividends to grow...
Computerplus company already paid $6 dividend per share this year
and expects the dividends to grow 10% annually for the next four
years and 7% annually thereafter. If the company decides to invest
in a new technology, it estimates that the dividends will not
increase for the next 5 years but the growth rate of the dividends
will be 11% thereafter. Required rate of return for the stock is
17%. In order to maximize the shareholder value, should the company
invest in the new technology or not?
Solutions
Expert Solution
Calculation of share price if company decided not to invest in new technology:
calculation of dividend for next 4 years
| Year | Dividend | |
| 1 | 6.60 | 6*1.1 |
| 2 | 7.26 | 6.6*1.1 |
| 3 | 7.99 | 7.26*1.1 |
| 4 | 8.78 | 7.99*1.1 |
Calculation of share price at the end of 4th year using dividend discount growth model
Share price = D1 / Ke - g
where,
D1 = next dividend i.e. $8.78 * 1.07 = $9.4
Ke =cost of equity i.e. 17%
g = growth rate i.e. 7%
share price = 9.4/17%-7% = $94
Calculation of share price today
| Year | Cash flows | Discount rate @17% | Present value | |
| 1 | 6.60 | 0.854700855 | 1/(1.17)^1 | $ 5.64 |
| 2 | 7.26 | 0.730513551 | 1/(1.17)^2 | $ 5.30 |
| 3 | 7.99 | 0.624370556 | 1/(1.17)^3 | $ 4.99 |
| 4 | 8.78 | 0.533650048 | 1/(1.17)^4 | $ 4.69 |
| 4 | 94.00 | 0.533650048 | 1/(1.17)^4 | $ 50.16 |
| present value | $ 70.78 |
share price = $70.78
Calculation of share price if company decided to invest in new technology:
Calculation of share price at the end of 5th year using dividend discount growth model
Share price = D1 / Ke - g
where,
D1 = next dividend i.e. $6 * 1.11 = $6.66
Ke =cost of equity i.e. 17%
g = growth rate i.e. 11%
share price = 6.66/17%-11% = $111
Calculation of share price today
| Year | Cash flows | Discount rate @17% | Present value | |
| 1 | 6.00 | 0.854700855 | 1/(1.17)^1 | $ 5.13 |
| 2 | 6.00 | 0.730513551 | 1/(1.17)^2 | $ 4.38 |
| 3 | 6.00 | 0.624370556 | 1/(1.17)^3 | $ 3.75 |
| 4 | 6.00 | 0.533650048 | 1/(1.17)^4 | $ 3.20 |
| 5 | 6.00 | 0.456111152 | 1/(1.17)^5 | $ 2.74 |
| 5 | 111.00 | 0.456111152 | 1/(1.17)^5 | $ 50.63 |
| present value | $ 69.82 |
share price = $69.82
hence, company should not invest in new technology.
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