Question

# Computech Corporation is expanding rapidly and currently needs to retain all of its earnings; hence, it...

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 45% per year - during Years 4 and 5, but after Year 5, growth should be a constant 6% per year. If the required return on Computech is 16%, what is the value of the stock today? Do not round intermediate calculations. Round your answer to the nearest cent.

\$

Solution :-

Required Return ( ke ) = 16%

Dividend in Year 3 ( D3 ) = \$0.50

D4 = \$0.50 * ( 1 + 0.45 ) = \$0.725

D5 = \$0.725 * ( 1 + 0.45 ) = \$1.051

Growth after Year 5 = 6%

P5 = D5 * ( 1 + g ) / (ke - g )

P5 = \$1.051 * ( 1 + 0.06 ) / ( 0.16 - 0.06 )

P5 = \$11.14

Now Value of Stock = D3 / ( 1 + ke )3 + D4 / ( 1 + ke )4 + ( D5 + P5 ) / ( 1 + ke )5

Value of Stock = \$0.50 / ( 1 + 0.16 )3 + \$0.725 / ( 1 + 0.16 )4 + ( \$1.05125 + \$11.14 ) / ( 1 + 0.16 )5

= ( \$0.50 * 0.641 ) + ( \$0.725 * 0.552 ) + ( \$12.19 * 0.476 )

= \$6.525

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