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 $0.50 coming 3 years from today. The dividend should grow rapidly - at a rate of 50% 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 12%, 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

D4= .5(1+.50) = .75

D5 = .75(1+.50) = 1.125

Terminal value at year5 = D5(1+G)/(Rs-g)

                    1.125(1+.10)/(.12-.10)

                     1.125 *1.1 /.02

                       61.875

value of stock today =[PVF 12%,3*D3]+[PVF12%,4*D5]+[PVF12%,5*D5]+[PVF 12%,5 *Terminal value]

=[.71178*.50]+[.63552*.75]+[.56743*1.125]+[.56743*61.875]

= .3559+ .4766+ .6384+ 35.1097

= $ 36.58

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