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 / 1.16³ + ($ 1.75 x 1.39) / 1.16⁴ + ($ 1.75 x 1.39²) / 1.16⁵ + 1 / 1.16⁵ x [ ($ 1.75 x 1.39² x 1.10) / (0.16 - 0.10)

= $ 1.75 / 1.16³ + $ 2.4325 / 1.16⁴ + $ 3.381175 / 1.16⁵ + 1 / 1.16⁵ x [ ($ 61.98820833) ]

= $ 1.75 / 1.16³ + $ 2.4325 / 1.16⁴ + $ 65.36938333 / 1.16⁵

= $ 33.59 Approximately

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