Stetson Corporation doesnt pay any dividends because it is expanding rapidly and

Question

Stetson Corporation doesnt pay any dividends because it is expanding rapidly and needs to retain all of its earnings. however, investors expect stetson 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 6%per year. if the required return on stock is 17%,what is the value of stock today (assume the market is in equilibrium with the required return equal to the expected return?

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*1.06)/(0.17-0.06)=$31.22181818(Approx)

Hence value of stock today=Future dividends*Present value of discounting factor(17%,time period)

=1/1.17^3+1.8/1.17^4+3.24/1.17^5+31.22181818/1.17^5

which is equal to

=$17.30(Approx).

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