Simpkins Corporation is expanding rapidly, and it does not pay and dividends bec

Question

Simpkins Corporation is expanding rapidly, and it does not pay and dividends because it currently 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 50% per- duringYears 4 and 5. After Year 5, the company should grow at a constant rate of 8% per year. If the required return on the stock is 15% what is the value of the stock today? Simpkins Corporation is expanding rapidly, and it does not pay and dividends because it currently 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 50% per- duringYears 4 and 5. After Year 5, the company should grow at a constant rate of 8% per year. If the required return on the stock is 15% what is the value of the stock today?

Explanation / Answer

We have Ks=15%, g=8% & Gs=50% So D3=1, D4=D3*(1+Gs) = 1*(1+50%) = 1.50, D5=1.50*(1+50%) = $2.25 After Y5, g=8%. So D6=D5*(1+g) = 2.25*(1+8%)= $2.43 Horizion Value at Y5=P5 = D6/(Ks-g) = 2.43/(15%-8%) = $34.71 SO P0 = D1/(1+ks)^1 + D2/(1+Ks)^2 + D3/(1+Ks)^3+ D4/(1+Ks)^4+ D5/(1+Ks)^5+PV of Horizon Value Y5 ie P0 = 0+0+1/(1+15%)^3+1.5/(1+15%)^4+2.25/(1+15%)^5+ 34.71/(1+15%)^5 ie P0 = $19.89 SO the value of the stock today is $19.89

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