Homework, part 2-Graded 13 at Noon CDT Activity Information Problem Walk-Through

Question

Homework, part 2-Graded 13 at Noon CDT Activity Information Problem Walk-Through NONCONSTANT GROWTH Computech Corporation is expanding rapidly and currently needs to retain all of its earnings; hence, it does not pay dividends. ávidends, begin ing with a dividend of $1 0 coming 3 years rom today. The dividend should grow rapidiy at a rate of 45% per year during Years 4 and 5: but after Year 5 gro th should be a constant 5% per year if the required return on cor putech s 14%, what is the value of the stock today? Round your answer to the nearest cent. Do not round your intermediate calculations owever, investors expect Computech to begin paying Check My Work non Ky pe here to search 0??

Explanation / Answer

The value of stock today is the present value of its future cash flows

2.175

(1.5 * 1.45)

3.15375

(2.175 * 1.45)

Since the growth rate after year 5 is constant, we can find the constant price of the share at the end of year 5 which is denoted as P5

P5 = D6 / (Ke - g)

Where P5 = Price at the end of year 5

D6 = Expected dividend for the 6th year = $3.15375 * 1.05 = $3.3114375

Ke = Required Rate of Return

g = Constant growth rate after year 5

Therefore, P5 = $3.3114375 / (0.14 - 0.05)

= $3.3114375 / 0.09

= $36.79375

Hence, the present value of stock is $23.05

Year Cash Inflows(in$) Present Value Factor @ 14% Present Value(in$) 3 1.5 0.6749 1.01235 4

2.175

(1.5 * 1.45)

0.5921 1.2878175 5

3.15375

(2.175 * 1.45)

0.5194 1.63805775 5 P5 = 36.79375 0.5194 19.11067375 Net Present Value 23.05

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