Simpkins Corporation does not pay any dividends because it is expanding rapidly

Question

Simpkins Corporation does not pay any dividends because it is expanding rapidly and needs to retain all of its earnings. However, investors expect Simpkins to begin paying dividends, with the first dividend of $1.50 coming 3 years from today. The dividend should grow rapidly - at a rate of 45% per year - during Years 4 and 5. After Year 5, the company should grow at a constant rate of 6% per year. If the required return on the stock is 13%, what is the value of the stock today (assume the market is in equilibrium with the required return equal to the expected return)? Round your answer to the nearest cent. Do not round your intermediate computations.

Explanation / Answer

year

calculation of stock price

year

Dividend present value @ 13 % present value of dividend 3 1.5 0.6931 1.04 4 2.17         [1.50 + ( 1.50 * 45 % ] 0.6133 1.33 5 3.14 [1.50 + ( 2.17 * 45 % ] 0.5428 1.70 5 Terminal value 47.43 0.5428 25.74 Present value of stock Today 29.81 terminal value = 3.14 (1+ 0.06) /[ 0.13 - 0.06]                         = 3.32 / 0.07 47.43

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