Nonconstant Growth Stock Valuation Simpkins Corporation does

Nonconstant Growth Stock Valuation 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 65% per year - during Years 4 and 5. After Year 5, the company should grow at a constant rate of 5% per year. If the required return on the stock is 17%, 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.

Solution

D3=$0.5

D4=(0.5*1.65)=$0.825

D5=(0.825*1.65)=$1.36125

Value after yer 5=(D5*Growth rate)/(Required return-Growth rate)

=(1.36125*1.05)/(0.17-0.05)

=$11.9109375

Current value of the stock=Future dividends*Present value of discounting factor(17%,time period)

=$0.5/1.17^3+$0.825/1.17^4+$1.36125/1.17^5+$11.9109375/1.17^5

which is equal to

=$6.81(Approx).