Simpkins Corporation does not pay any dividends because it is expanding rapidly

Question

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 $1.00 coming 3 years from today. The dividend should grow rapidly - at a rate of 80% 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 16%, 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.

Explanation / Answer

D4=(1*1.8)=$1.8

D5=(1.8*1.8)=$3.24

Value after year 5=(D5*Growth rate)/(Required return-Growth rate)
=(3.24*1.05)/(0.16-0.05)
=$30.92727273(Approx)

Hence value of the stock today=Future dividends*Present value of discounting factor(16%,time period)

=1/1.16^3+1.8/1.16^4+3.24/1.16^5+$30.92727273/1.16^5

which is equal to

=$17.90(Approx).

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