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