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 $1.25 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.
1. If the required return on Computech is 18%, what is the value of the stock today?

Answer 1

Answer:

$10.98

Explanation:

Dividend per year;

D1 to D2 = 0

D3 = 1.25

D4 = 1.25 (1.21) = 1.5125

D5 = 1.5125 (1.21) = 1.8301

D6 = 1.8301 (1.08) =1.9765

Find Present values of each dividend at 18% required return;

PV( D1 to D2) = 0

PV( D3) = 1.25/1.18³ = 0.7608

PV( D4) = 1.5125 / (1.18^4) = 0.7801

PV( D5) = 1.8301 / (1.18^5) = 0.8000

PV( D6 onwards) $= \frac{\frac{1.9765}{(0.18-0.08)} }{1.18^{5} } \\ \\ =\frac{19.765}{2.2878}$

PV( D6 onwards) = 8.6393

Next, sum up the PVs;

= 0 + 0.7608 + 0.7801 + 0.8000 + 8.6393

= 10.98

Therefore, this stock is valued at $10.98