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 $1.50 coming 3 years from today. The dividend should grow rapidly-at a rate of 15% per year-during Years 4 and 5; but after Year 5, growth should be a constant 5% per year. 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

The formula for dividend discount model is below:

Intrinsic value = PV of high growth phase dividends + PV of stable growth phase dividends

Where,

Dn = Dividend in the given year

r = cost of equity

Since the first divident will be paid in year 3,

The PV of dividend paid in year 3 will be

PV = 1.5 / (1.15^3) = $0.9862

Now in 4th and 5th year the dividen growth is 15%

Hence, PV in 4th year = 1.5*(1.15) / (1.15^4) = 1.725 / (1.15^4) = $0.98625

PV in 5th yr = 1.7255*(1.15) / (1.15^5) = 1.98375 / (1.15^5) = $0.98625

Now, in terminal year the PV will be = (1.98375 * (1.05) / (0.15 - 0.05)) / (1.15^5) = $10.3754

Therefore,

PV or current market price = $0.9862 +$0.9862 +$0.9862 + $10.3754

= $13.334