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 $1.25 coming 3 years from today. The dividend should grow rapidly - at a rate of 40% per year - during Years 4 and 5; but after Year 5, growth should be a constant 10% per year. The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the question below.

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

Given about Commputech Corporation,

Computech to begin paying dividends, beginning with a dividend of $1.25 coming 3 years from today

So, D3 = $1.25

growth rate for next 2 year = 40%

So, D4 = D3*1.40 = 1.25*1.40 = $1.75

D5 = D4*1.40 = 1.75*1.40 = $2.45

thereafter growth rate g = 10%

required return on Computech rs = 16%

So, price of stock at year 5 using constant dividend growth model is

P5 = D5*(1+g)/(rs-g) = 2.45*(1.10)/(0.16-0.10) = $44.9167

So, price of stock today is sum of PV of future dividends and P5 discounted at rs

P0 = D3/(1+rs)^3 + D4/(1+rs)^4 + D5/(1+rs)^5 + P5/(1+rs)^5

P0 = 1.25/1.16^3 + 1.75/1.16^4 + 2.45/1.16^5 + 44.9167/1.16^5 = $24.32

value of the stock today = $24.32