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 coming 3 years from today. The dividend should grow rapidly at a rate of 40% 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 10%, what is the value of the stock today

Answer 1

Answer:

The value of the stock today is $28.48

Explanation:

To calculate the value of the stock today, we will use the Dividend discount model which bases the value of a stock based on the present value of the expected future dividends from the stock. The value of the stock today using this model should be,

P0 = 1 / (1+0.1)^3  +  1 * (1+0.4) / (1+0.1)^4  +  1 * (1+0.4)^2 / (1+0.1)^5  +  

[ (1 * (1+0.4)^2 * (1+0.05)  /  (0.10 - 0.05))  /  (1+0.1)^5 ]

P0 = $28.48