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 $0.75 coming 3 years from today. The dividend should grow rapidly - at a rate of 45% 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 17%, what is the value of the stock today? Do not round intermediate calculations. Round your answer to the nearest cent.

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 ) ]

= $ 0.75 / 1.17³ + ( $ 0.75 x 1.45 ) / 1.17⁴ + ( $ 0.75 x 1.45² ) / 1.17⁵ + 1 / 1.17⁵ [ ($ 0.75 x 1.45² x 1.08) / ( 0.17 - 0.08) ]

= $ 0.75 / 1.17³ + $ 1.0875 / 1.17⁴ + $ 1.576875 / 1.17⁵ + $ 18.9225 / 1.17⁵

= $ 0.75 / 1.17³ + $ 1.0875 / 1.17⁴ + $ 20.499375 / 1.17⁵

= $ 10.40 Approximately

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