AAA Company is expanding rapidly and currently needs to retain all of its earnin

Question

AAA Company is expanding rapidly and currently needs to retain all of its earnings; hence, it does not pay dividends in Year 1. However, investors expect AAA to begin paying dividends, beginning with a dividend of $0.50 in Year 2. The dividend should grow rapidly—at a rate of 30% per year—during Years 3 and 4; but after Year 4, growth should be a constant 5% per year. If the required return on AAA is 10%, what is the value of the stock today? (Draw a timeline to visualize the problem and show the detailed steps of your analysis)

Explanation / Answer

value = 13.60

10.00% Cash flows Year Discounted CF                             -   0 0.00                             -   1 0.00                         0.50 2 0.41                         0.65 3 0.49                         0.85 4 0.58                      17.75 4 12.12

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