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 $0.50 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 4% per year. If the required return on Computech is 12%, what is the value of the stock today? Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

The value 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 x [ (Dividend in year 5 x (1 + growth rate) / (required rate of return - growth rate) ]

= $ 0.50 / 1.12³ + ($ 0.50 x 1.40) / 1.12⁴ + ($ 0.50 x 1.40²) / 1.12⁵ + 1 / 1.12⁵ x [ (($ 0.50 x 1.40² x 1.04) / (0.12 - 0.04) ]

= $ 0.50 / 1.12³ + $ 0.70 / 1.12⁴ + $ 0.98 / 1.12⁵ + 1 / 1.12⁵ x [ ($ 12.74) ]

= $ 0.50 / 1.12³ + $ 0.70 / 1.12⁴ + $ 13.72 / 1.12⁵  

= $ 8.59 Approximately

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