Problem:

You want to invest in MicroSoft Company. The MicroSoft currently is paying no dividend because of depressed earnings. A recent change in management promises, however, a brighter future. Investors expect Micro Soft to pay a dividend of $1 next year (the end of the year). This dividend is expected to increase to $2 the following year and to grow at a rate of 10 percent per annum for the following two years (years 3 and 4). A good new investor, expects the price of the stock to increase 50 percent in value between now (time zero) and the end of year 3.

Required:

If the investor plans to hold the stock for two years and requires a rate of return of 20 percent on the investor, what value would he place on the stock today? Please provide step by step solution and also show your workings.