Question

# NONCONSTANT GROWTH Computech Corporation is expanding rapidly and currently needs to retain all of its earnings;...

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.

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 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

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