Problem 9-14 Nonconstant growth Microtech Corporation is expanding rapidly and c

Question

Problem 9-14
Nonconstant growth

Microtech Corporation is expanding rapidly and currently needs to retain all of its earnings; hence, it does not pay dividends. However, investors expect Microtech 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 48% per year - during Years 4 and 5; but after Year 5, growth should be a constant 4% per year. If the required return on Microtech is 12%, what is the value of the stock today? Round your answer to the nearest cent.

Problem 9-14
Nonconstant growth

Microtech Corporation is expanding rapidly and currently needs to retain all of its earnings; hence, it does not pay dividends. However, investors expect Microtech 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 48% per year - during Years 4 and 5; but after Year 5, growth should be a constant 4% per year. If the required return on Microtech is 12%, what is the value of the stock today? Round your answer to the nearest cent.

Explanation / Answer

D4=(0.75*1.48)=$1.11

D5=(1.11*1.48)=$1.6428

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

=(1.6428*1.04)/(0.12-0.04)

=$21.3564

Hence current value=Future dividends*Present value of discounting factor(12%,time period)

=0.75/1.12^3+1.11/1.12^4+1.6428/1.12^5+21.3564/1.12^5

which is equal to

=$14.29(Approx).

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