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 18% per year-during Years 4 and 5; but after Year 5, growth should be a constant 9% per year. If the required return on Computech is 14%, what is the value of the stock today? Round your answer to the nearest cent. Do not round your intermediate calculations.

Answer 1

Dividend year 3 = 1.00

Dividend year 4 = D3*(1 + r) = 1.00*(1+18%) = 1.18

Dividend year 5 = D4*(1+r) = 1.18*(1+18%) = 1.3924

Dividend year 6= D5*(1+r) = 1.3924*(1+9%) = 1.517716

{Constant growth rate thereafter = 9%}

D= Dividend , r= rate

Terminal value at the end of year 5 = D6 /(required return - growth rate) = 1.517716 / (0.18 - 0.09) = 16.86351

Value of the stock today = Dividend year 3 /(1+r)^3 + Dividend year 4 /(1+r)^4 + Dividend year 5/(1+r)^5 + Terminal value /(1+r)^5

value of the stock today = 1.00/(1+0.18)^3 + 1.18/(1+0.18)^4 + 1.3924/(1+0.18)^5 + 16.86351/(1+0.18)^5

value of the stock today = $9.197