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 $1.00 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 8% per year. If the required return on Computech is 15%, what is the value of the stock today? Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

The value of the stock is computed as shown below:

= Dividend in year 3 / (1 + required rate of return)³ + Dividend in year 4 / (1 + required rate of return)⁴ + Dividend in year 5 / (1 + required rate of return)⁵ + 1 / (1 + required rate of return)⁵ [ (Dividend in year 5 (1 + growth rate) / ( required rate of return - growth rate ) ]

= $ 1 / 1.15³ + ( $ 1 x 1.42 ) / 1.15⁴ + ( $ 1 x 1.42² ) / 1.15⁵ + 1 / 1.15⁵ [ ($ 1 x 1.42² x 1.08) / ( 0.15 - 0.08) ]

= $ 1 / 1.15³ + $ 1.42 / 1.15⁴ + $ 2.0164 / 1.15⁵ + $ 31.11017143 / 1.15⁵

= $ 17.94 Approximately

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