6 . Micron corporation is expanding rapidly and currently needs to retain all of

ID: 2819544 • Letter: 6

Question

6. Micron corporation is expanding rapidly and currently needs to retain all of its earnings; hence, it does not pay dividends. However, investors expect Micron to being paying dividends, beginning with a dividend of $1.00 coming 3 years from today. The dividends should grow rapidly ------ at a rate of 50% per year ----- during year 4 and 5; but after year 5, growth should be a constant 8% per year. If the required return on Microtech is 15%, what is the value of the stock today? No excel step by step process.

Explanation / Answer

Years

Dividend Growth

Dividend

D1 = $0.00

D2 = $0.00

D3 = $1.00

50%

D4 = 1 + (1+50%) = D4 = $1.50

50%

D5 = 1.50 x (1+50%) = D5 = $2.25

Price of share at year 5 = D5 x (1+Growth rate) / (Required rate - Growth rate)

Price of share at year 5 = P5 = 2.25 x (1+8%) / (15% - 8%) = 34.71429

Price of stock today = P0 = D3 / (1+R)^3 + D4 / (1+R)^4 + D5 / (1+R)^5 + P5 / (1+R)^5

P0 = $1 / (1+15%)^3 + $1.5 / (1+15%)^4 + $2.25 / (1+15%)^5 + $34.71429 / (1+15%)^5

Price of stock today = $19.89