Computech Corporation is expanding rapidly and currently needs to retain all of

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 $1.75 coming 3 years from today. The dividend should grow rapidly-at a rate of 34% 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 12%, what is the value of the stock today? Round your answer to the nearest cent.

Explanation / Answer

D3 = 1.75

D4 = 1.75*1.34

D5 = 1.75*1.34^2

D6 = 1.75*1.34^2*1.08

According to dividend-discount model,

P0 = D1/(R-G)

P0 = Current stock price

D1 - Dividend at t =1

R - Required rate

G - Growth rate

P5 = D6/(R-g) = 1.75*1.34^2*1.08/(0.12-0.08) = 84.84

P0 is calculated by discounting the future dividends and P5

P0 = 1.75/(1+0.12)^3 + 1.75*1.34/(1+0.12)^4 + 1.75*1.34^2/(1+0.12)^5 + 84.84/(1+0.12)^5 = 52.66

Current stock price = $52.66

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