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 $0.75 coming 3 years from today. The dividend should grow rapidly - at a rate of 50% 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 15%, what is the value of the stock today? Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

Current stock price is $ 14.92

As per dividend discount model, current stock price is the present value of dividends which is calculated as follows:
Step-1:Present Value of non-constant growth stage dividend
Year	Dividend	Discount factor	Present Value
a	b	c=1.15^-a	d=b*c
3	0.75	0.658	0.49
4	1.13	0.572	0.64
5	1.69	0.497	0.84
Total			1.98
Working:
Dividend of year:
3					=	0.75
4	=	0.75	*	1.50	=	1.13
5	=	1.125		1.50	=	1.69
Step-2:Present value of constant growth stage dividend
Present Value	=	D5*(1+g)/(Ke-g)*DF5
	=	12.94
Where,
D5	=	Year 5 dividend	=	1.69
g	=	Growth Rate	=	8%
Ke	=	Required Return	=	15%
DF5	=	Discount factor of Year 5	=	0.497
Step-3:Calculation of current price of stock
Current Price	=	Present Value of dividends
	=	1.98	+	12.94
	=	14.92