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 $1.25 coming 3 years from today. The dividend should grow rapidly-at a rate of 44% per year-during Years 4 and 5; but after Year 5, growth should be a constant 9% per year. If the required return on Computech is 17%, what is the value of the stock today? Round your answer to the nearest cent. Do not round your intermediate calculations.

$____

Answer 1

	This is a problem from two phase dividend growth model -
Step 1 -	Explicit forecast period =
	Year	Dividend		PV factor @ 17%	PV of Dividends
	1		0	0.8547	0.0000
	2		0	0.7305	0.0000
	3		1.25	0.6244	0.7805
	4	1.25 x 1.44 =	1.8	0.5337	0.9606
	5	1.8 x 1.44 =	2.592	0.4561	1.1822
					2.9233
Step 2 -	Horizon period =
	Terminal value at t=5
	=	D6/(Re - g)
	here, D6 =	Dividend for the year 6		= 2.592 x 1.09 =	2.82528
	Re =	required return			17%
	g =	growth (Constant)			9%
	Terminal value(Or price at t=5) =			2.82528/(0.17-0.09)
				35.316
	PV of terminal value =			Terminal value x PV factor for 5 years
				35.316 x 0.4561
				16.10802
Step 3 =	Value of stock today =			Step 1 + step 2
			=	2.9233 + 16.1080
				19.0313
				Answer