Microtech Corporation is expanding rapidly and currently needs to retain all of
ID: 2628182 • Letter: M
Question
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 $1.00 coming 3 years from today. The dividend should grow rapidly - at a rate of 33% per year - during Years 4 and 5; but after Year 5, growth should be a constant 6% per year. If the required return on Microtech is 12%, what is the value of the stock today?
PLease show work. Will choose best answer if it's right. Thanks.
Explanation / Answer
Dividend at the end of year 3 = $ 1
Dividend at the end of year 4 = 1*(1+ growth rate ) = 1*(1+0.33) = $1.33
Dividend at the end of year 5 = $1.33*(1.33) = $1.77
Dividend at the end of year 6 = $1.77* ( 1+ growth rate) = 1.77*(1+0.06) = 1.88
Using Gordan growth model,
Stock value at the end of year 5 = Divident at the end of year 6/(K- G)
K = Required rate of return for investor= 12%
G = growth rate in dividends = 6%
Stock value at the end of year 5 = 1.88/(0.12-0.06) = $31.33
Stock value today = Expected dividends for year 3,4,5 discounted @ 12% + discounted stock price after 5 years
= 1/1.12^3 + 1.33/1.12^4 + 1.77/1.12^5 + 31.33/1.12^5
=$20.34