Question

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 $1.75 coming 3 years from today. The dividend should grow rapidly-at a rate of 43% 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 12%, what is the value of the stock today

Answer 1

Value of stock today = $35.32

Step-by-step explanation:

PV of dividend payable in year 3

= 1.75× (1.12)^(-3)

= 1.245

PV of Dividend in year 4

1.75× (1.43) × 1.12^(-4)

=1.590

PV of dividend in year 5

1.75 × (1.43)^2 × 1.12^(-5)

=2.030

PV of Dividend from year 6 onward

Step 1: calculate the PV (in year 5 term)

(1.75 × (1.43)^2)× (1.05)/(0.12-0.05)

=53.67

Step 2: re-discount to get PV in year 0 term

53.67 × 1.12^(-5)

=30.45

Value of stock today

1.245 +1.590 + 2.030+30.45

=35.32

Value of stock today = $35.32