NONCONSTANT GROWTH Computech Corporation is expanding rapidl

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 $1.25 coming 3 years from today. The dividend should grow rapidly-at a rate of 17% 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 18%, what is the value of the stock today? Round your answer to the nearest cent. Do not round your intermediate calculations.

Solution

D4=(1.25*1.17)=$1.4625

D5=(1.4625*1.17)=$1.711125

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

=(1.711125*1.05)/(0.18-0.05)

=$13.820625

Hence current value of the stock=Future dividends*Present value of discounting factor(18%,time period)

=1.25/1.18^3+$1.4625/1.18^4+$1.711125/1.18^5+$13.820625/1.18^5

which is equal to

$8.30(Approx).