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 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 39% per year - during Years 4 and 5; but after Year 5, growth should be a constant 10% per year. If the required return on Microtech is 12%, what is the value of the stock today? Round your answer to the nearest cent.

Explanation / Answer

Solution:-

Calculate the future dividends:D1=D0(1+g) where D1 current dividend and D0 previous year dividend

D3 = 1.25
D4 = 1.25 * (1 .39) = 1.74
D5 = 1.74* (1.39) = 2.42
D6 = 2.42 * (1 .1) = 2.66

Value of stock=PV of expected future dividends

from6 year onwars dividend will 2.66 so using PV of perpetuity

PVof perpetuity=Annual payment/required rate of return
=2.66/0.13 =20.5

Thus Value of stock=PV of expected future dividends
=(1.11+0.98+0.87+1.07+1.31+20.5)
= $ 25.84

year Dividend amount PVF@13% PV 1 1.25 0.885 1.11 2 1.25 0.783 0.98 3 1.25 0.693 0.87 4 1.74 0.613 1.07 5 2.42 0.543 1.31

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