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 $0.75 coming 3 years from today. The dividend should grow rapidly-at a rate of 16% 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 14%, what is the value of the stock today? Round your answer to the nearest cent. Do not round your intermediate calculations.

Answer 1

Answer:

The intrinsic value of the stock is 9.76

Explanation:

We have to use the dividend growth model

It is fundamental to understand that these values are in the future so we must take them to present value, using the required return of 14%

$\left[\begin{array}{ccc}-&DIVIDENDS&PRESENT VALUE\\1&0&0\\2&0&0\\3&0.75&0.506228637151512\\4&0.87&0.515109841312065\\5&1.0092&8.73578093453209\\Intrinsic&Value&9.75711941299567\\\end{array}\right]$

We multiply year 3 by 1.16 to get year 4

Then we multiply year 4 by 1.16 to get year 5 dividends.

Then we use the dividend growth model to get the value ofthe future years

$\frac{dividends}{return-growth} = intrinsic \: value$

Again, this value is set 5 years into the future, so we have to calculate the present value

$\frac{intrinsic \: value}{1.14^{5} } = Present Value$

Same process is done for year 3 and 4

$\frac{.75}{1.14^{3} } = PV \: Year3$

$\frac{.87}{1.14^{4} } = PV \: Year4$

Then we add the three values to get the value of the stock today.