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Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
Textbook Problem

NONCONSTANT GROWTH Computech Corporation is expanding rapidly and currently needs to retain all of its earnings; hence, it does not pay dividends. However, investors expect Computech 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 7% per year. If the required return on Computech is 13%, what is the value of the stock today?

Summary Introduction

To determine: The value of the stock for the current day.

Introduction:

Horizon Value:

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

Explanation

Given information:

Dividend paid is $0.50.

Non-constant growth rate is 35%.

Return on stock is 13%.

Constant growth rate is 7%.

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

Where,

  • P0 is the horizon value

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