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 $1.75 coming 3 years from today. The dividend should grow rapidly - at a rate of 39% per year - during Years 4 and 5; but after Year 5, growth should be a constant 10% per year.

If the required return on Computech is 16%, what is the value of the stock today? Round your answer to the nearest cent. Do not round your intermediate calculations.

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) ]**

= $ 1.75 / 1.16^{3} + ($ 1.75 x 1.39) / 1.16^{4}
+ ($ 1.75 x 1.39^{2}) / 1.16^{5} + 1 /
1.16^{5} x [ ($ 1.75 x 1.39^{2} x 1.10) / (0.16 -
0.10)

= $ 1.75 / 1.16^{3} + $ 2.4325 / 1.16^{4} + $
3.381175 / 1.16^{5} + 1 / 1.16^{5} x [ ($
61.98820833) ]

= $ 1.75 / 1.16^{3} + $ 2.4325 / 1.16^{4} + $
65.36938333 / 1.16^{5}

**= $ 33.59 Approximately**

Feel free to ask in case of any query relating to this question

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