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 $2.00 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 10% per year. If the required return on Computech is 18%, what is the value of the stock today? Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

Statement showing price of stock today

Year	Dividend	PVIF @ 18%	PV
1			0.8475	0.00
2			0.7182	0.00
3		2	0.6086	1.22
4	2(1.37)	2.74	0.5158	1.41
5	2.74(1.37)	3.75	0.4371	1.64
Horizon Value		51.56	0.4371	22.54
Price of stock today	26.81

Thus price of stock today = $ 26.81

i,e $ 27

Horizon Value = Dividend for year 6 / Required rate of return - growth rate

growth rate = 10%

Required rate of return = 18%

Dividend for year 6 = Dividend for year 5(1+ growth rate)

= 3.75(1+10%)

=3.75(1.1)

=4.13

Thus Dividend for year 6 = 4.13/18%-10%

=4.13/8%

= $ 51.56