Microtech Corporation is expanding rapidly and currently needs to retain all of

Question

Microtech Corporation is expanding rapidly and currently needs to retain all of its earnings, hence it does not pay dividends. However, investors expects 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 40 percent per year-during                 Years 4 and 5, but after Year 5 growth should be constant 8 percent per year. If the required return on Microtech is 15 percent, what is the value of  the                 stock today?             

Explanation / Answer

Hi,

Please find the answer as follows:

D3 = 1

D4 = 1*(1+.40) = 1.40

D5 = 1*(1+.40)^2 = 1.96

Present Value of all Dividends = 1/(1+.15)^3 + 1.40/(1+.15)^4 + 1.96/(1+.15)^5 = 2.43

Present Value of Price at the End of 5 Year = 1.96*(1+.08)/(.15-.08)(1+.15)^5 = 15.03

Price of Stock Today = Present Value of all Dividends + Present Value of Price at the End of 5 Year = 2.43 + 15.03 = 17.46

Answer is 17.46

Thanks.

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