Question

Computech Corporation is expanding rapidly and currently needs to retain all of its earnings; hence, it does not pay dividends. However, investors expect Computech to begin paying dividends, beginning with a dividend of $1.75 coming 3 years from today. The dividend should grow rapidly - at a rate of 42% per year - during Years 4 and 5; but after Year 5, growth should be a constant 6% per year. The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the question below.

If the required return on Computech is 15%, what is the value of the stock today? Round your answer to the nearest cent. Do not round your intermediate calculations.

Answer 1

D3 = 1.75. D4 = 1.75*(1+42%) = 2.4850 and D5 = 2.4850*(1+42%) = 3.5287. D6 = 3.5287*(1+6%) = 3.7404

Terminal value at the end of year 5 = D6/r-g = 3.7404/(15%-6%) = 41.5602

Thus value of stock today = D3/(1+r)^3 + D4/(1+r)^4 + D5/(1+r)^5 + Terminal value/(1+r)^5

= 1.75/1.15^3 + 2.4850/1.15^4 + 3.5287/1.15^5 + 41.5602/1.15^5

= $24.99

The excel work can be seen below:

Year	Dividend	growth rate	1+r	PVIF	PV = dividend * PVIF
3	1.7500		1.15	0.6575	1.15
4	2.4850	42%		0.5718	1.42
5	3.5287	42%		0.4972	1.75
6	3.7404	6%
Terminal value	41.5602			0.4972	20.66
				Total = sum of present values of dividends of years 3 to 5 and terminal value	24.99

Thus value of stock today is $24.99