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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

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 $1.00 coming 3 years from today. The dividend should grow rapidly—at a rate of 50% per year—during Years 4 and 5; but after Year 5, growth should be a constant 8% per year. If the required return on Microtech is 15%. what is the value of the stock today?

Summary Introduction

To determine: The value of the stock today.

Horizon Value

It is the present value of all cash inflows and outflows likely to occur at future date with g constant growth rate after that date. The time period up to which the company has non-constant growth rate is known as horizon date.

Explanation

Given,

Dividend paid is $1.

Non-constant growth rate is 50%.

Return on stock is 15%

Constant growth rate is 8%.

The price of the stock will be:

P0=D3(1+rs)3+D4(1+rs)4+D5(1+rs)5+DN(1+gn)rsgn(1+rs)=D3(1+rs)3+D3(1+gs)(1+rs)4+D3(1+gs)2(1+rs)4+D3(1+gs)2(1+gn)rsgn(1+rs)4

Substitute values $1 for, 0

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