Nonconstant growth Microtech Corporation is expanding rapidly and currently need

Question

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 50% per year - during Years 4 and 5; but after Year 5, growth should be a constant 8% per year. If the required return on Microtech is 18%, what is the value of the stock today? Round your answer to the nearest cent.

Explanation / Answer

Total pv factor Present Year Dividend Stock Price Cashflow at 18% Value 1 0 0.847458 0.00 2 0 0.718184 0.00 3 0.75 0.75 0.75 0.608631 0.46 4 =0.75 x 1.5 1.125 1.125 0.515789 0.58 5 =0.75 x 1.5 x 1.5 1.6875 1.6875 0.437109 0.74 6 =0.75x1.5x1.5x0.08 1.8225 22.78 24.60375 0.370432 9.11 Total 10.89 in 6th year dividend growth become constant. And dividend income is 1.8225 per share Hence, Price of shares in 6th year = 1.8225/0.08 = 22.78. Current price of the share = $10.89

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