Question

Nonconstant growth

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 $1.00 coming 3 years from today. The dividend should grow rapidly - at a rate of 21% per year - during Years 4 and 5; but after Year 5, growth should be a constant 5% per year. 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

Present value (PV) = sum of present value of all future cash flows

Assuming returns are generated from dividends only,

After end of 5 years there is a perpetuity model with constant dividend growth which can be calculated using the formula Dividend * (1+ dividend growth rate)/ (return rate - growth rate) which needs to be discounted back from year 5 to year 0 (present value)

PV = 2/(1+16%)^3+2*(1+21%)/(1+16%)^4+2*(1+21%)^2/(1+16%)^5+2*(1+21%)^2*(1+5%)/(16%-5%)/(1+16%)^5=$17.32