Nonconstant growth 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 $0.50 coming 3 years from today. The dividend should grow rapidly – at a rate of 35% 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 13%, what is the value of the stock today? Round your answer to the nearest cent.
nswer : the value of the stock today is $ 19.34
Working notes for the above answer is as follow
Here we have provided that,
beginning with a dividend of $0.50 coming 3 years from today
So D3 = 0.50
The dividend should grow rapidly – at a rate of 35% per year – during Years 4 and 5
So D4 = D3*1.35
= 0.50*1.35
=0.676
So D5 = D4*1.35
= 0676.*1.35
=0.911
but after Year 5, growth should be a constant 10% per year
D6 =0.911*1.10
=1
Using D6, find P5 (constant growth model with g = 10% and r = 13%)
= 1 /0.13-010
=1/0.03
=33.33
Now we will calculte the presant value of devidend and price of D5 as follow
| Discoun and Price |
Dividend | Price | PV factor@13% | PV |
| D3 | 0.5 | 0.693050162 | 0.346525 | |
| D4 | 0.676 | 0.613318728 | 0.414603 | |
| D5 | 0.911 | 0.542759936 | 0.494454 | |
| P5 | 33.33 | 0.542759936 | 18.09019 | |
| 19.34577 |
So price of the stock today is $ 19.34
