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 23% per year-during Years 4 and 5; but after Year 5, growth should be a constant 8% 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.

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Answer 1

The dividends starts paying from Year3 onwards as per the question, Hence, D1=0 and D2=0

D3=$2

D4=$2*(1+23%)=$2.46

D5=$2.46*(1+23%)=$3.03

D6=$3.03*(1+8%)=$3.27

The growth of 8% continue forever

Terminal value at Year 5=D6/(required rate-growth rate)

=$3.27/(14%-8%)=$54.46

Value of the Stock=(D1/(1+14%))+(D2/(1+14%)^2)+(D3/(1+14%)^3)+(D4/(1+14%)^4)+((D5+Terminal value at Year5)/(1+14%)^5)

=0+0+(2/1.14^3)+(2.46/1.14^4)+(57.49/1.14^5)

=1.35+1.46+29.86

=$32.67

Value of the Stock=$32.67