Question

Investors expect Microtech to pay the first dividend of $1.25 at the end of Year 2. The dividend should grow at a rate of 8 percent per year during Years 3, 4, and 5. The stock can be sold for $42 at the end of Year 5. Determine the current market value of the company’s stock if the required rate of return is 12 percent.

Please show work

Answer 1

Price of Stock today is the present value of inflows received during the five years of life:
Therefore, the present value is computed as under:
Year	Inflows	PVf at 12%	Present value
1	0	0.892857	0
2	1.25	0.797194	0.996492
3	1.35	0.71178	0.960903
4	1.458	0.635518	0.926585
5	1.57464	0.567427	0.893493
5	42	0.567427	23.83193
Present value			27.61
Therefore, the price of stock today is $ 27.61
Note: Dividend for Year 3 = Dividend of Year2 i.e. 1.25 + 8% =1.35
Dividend for Year-4 = Dividend for Year-3 + 8% = 1.35+8% = 1.458
Dividend for Year-5 = Dividend for Year-4 + 8% = 1.458+8% = 1.57464