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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