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 $0.75 coming 3 years from today. The dividend should grow rapidly - at a rate of 37% 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 12%, what is the value of the stock today? Round your answer to the nearest cent. Do not round your intermediate calculations.

Answer #1

Year | Dividend |

1 | $ - |

2 | $ - |

3 | $ 0.75 |

4 | $ 1.03 |

5 | $ 1.41 |

6 | $ 1.52 |

Price P5 | $ 38.01 |

Price today | $ 23.55 |

Forecast the dividend given the growth rates as shown above.

Price in year 5 = D6 / (r - g) = 1.52 / (12% - 8%) = $38.01

Price today, P0 = D3 / (1 + r)^3 + D4 / (1 + r)^4 + (D5 + P5) / (1 + r)^5

= 0.75 / 1.12^3 + 1.03 / 1.12^4 + (1.41 + 38.01) / 1.12^5

= $23.55

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