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 $1.00 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 10% per year. If the required return on the stock is 15%, what is the value of the stock today? Round your answer to the nearest cent. Do not round your intermediate computations.

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Explanation / Answer

Hi,

Please find the detailed answer as follows:

You need to find the present value of all the future dividends and stock price at the end of Year 5.

Current Stock =1/(1+.15)^3 + 1*(1+.45)/(1+.15)^4 + 1*(1+.45)^2/(1+.15)^5 + 1*(1+.45)^2*(1+.10)/(1+.15)^5*(.15 -.10) = 25.52 or 25.5

Answer is 25.52 or 25.5.

Thanks.

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