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 $0.50 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 8% per year. If the required return on Computech is 12%, what is the value of the stock today? Round your answer to the nearest cent. Do not round your intermediate calculations

Answer #1

g_{1} = growth rate in year 4 and 5 = 0.21 ,
g_{2} = growth rate after year 5, Ke = required return =
0.12

D3 (Dividend in Year 3) = $0.50

D4 (Dividend in Year 4) = D3 x (1 + g_{1}) = $0.50 x (1
+ 0.21) = $0.605

D5 (Dividend in Year 5) = D4 x (1 + g_{1}) = $0.605 x (1
+ 0.21) = $0.73205

P5 (Price at the end of year 5) = D5 x (1 + g_{2}) / (Ke
- g_{2}) = $0.73205 x (1 + 0.08) / (0.12 - 0.08) =
$19.76535

Value of stock today is the present value of the above cash flows -

Particulars | Year | PVIF@12% | Amount | Present value |

D3 | 3 | 0.7117802478 | $0.50 | $0.36 |

D4 | 4 | 0.63551807839 | $0.605 | $0.38 |

D5 | 5 | 0.5674268557 | $0.73205 | $0.42 |

P5 | 5 | 0.5674268557 | $19.76535 | $11.21 |

Value of stock today |
$12.37 |

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