Click here to read the eBook: Valuing Nonconstant Growth Stocks Problem Walk-Thr
ID: 2618586 • Letter: C
Question
Click here to read the eBook: Valuing Nonconstant Growth Stocks Problem Walk-Through NONCONSTANT GROWTH 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 $2.00 coming 3 years from today. The dividend should grow rapidly-at a rate of 25% 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 15%, what is the value of the stock today? Round your answer to the nearest cent. Do not round your intermediate calculations.
Explanation / Answer
D4=(2*1.25)=$2.5
D5=(2.5*1.25)=$3.125
Value after year 5=(D5*Growth rate)/(Required return-Growth rate)
=(3.125*1.05)/(0.15-0.05)=$32.8125
Hence current value=Future dividends*Present value of discounting factor(15%,time period)
=2/1.15^3+2.5/1.15^4+3.125/1.15^5+32.8125/1.15^5
which is equal to
=$20.61(Approx).
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