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 39% 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? Do not round intermediate calculations. Round your answer to the nearest cent.

Answer #1

Dividend in Year-3 = 1.25 | ||||

Dividend in Year-4 = 1.25 +39% = 1.74 | ||||

Dividend in Yeara-5 = 1.74+39% = 2.42 | ||||

Dividend for Year-6 = 2.42 +8% = 2.61 | ||||

Horizon value at Year-5 = 2.61 / (14-8)% = 43.50 | ||||

Stock price: | ||||

Year | Cashflows | PVF at 14% | Present value | |

1 | 0 | 0.877193 | 0 | |

2 | 0 | 0.769468 | 0 | |

3 | 1.25 | 0.674972 | 0.843714 | |

4 | 1.74 | 0.59208 | 1.03022 | |

5 | 2.42 | 0.519369 | 1.256872 | |

5 | 43.5 | 0.519369 | 22.59254 | |

Stock price today | 25.72 | |||

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to retain all of its earnings; hence, it does not pay dividends.
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