Question

Holt Enterprises recently paid a dividend, D₀, of $3.00. It expects to have nonconstant growth of 13% for 2 years followed by a constant rate of 5% thereafter. The firm's required return is 10%.

1. How far away is the horizon date?
   1. The terminal, or horizon, date is the date when the growth rate becomes nonconstant. This occurs at time zero.
   2. The terminal, or horizon, date is the date when the growth rate becomes constant. This occurs at the beginning of Year 2.
   3. The terminal, or horizon, date is the date when the growth rate becomes constant. This occurs at the end of Year 2.
   4. The terminal, or horizon, date is infinity since common stocks do not have a maturity date.
   5. The terminal, or horizon, date is Year 0 since the value of a common stock is the present value of all future expected dividends at time zero.
   
   -Select-IIIIIIIVVItem 1
   
2. What is the firm's horizon, or continuing, value? Round your answer to two decimal places. Do not round your intermediate calculations.
   
   $
   
3. What is the firm's intrinsic value today, P̂₀? Round your answer to two decimal places. Do not round your intermediate calculations.
   
   $

Answer 1

(a) The terminal or horizon date is the date when the growth rate becomes constant. This occurs at the end of Year 2 (as growth rate os 13 % for Year 1 and Year 2)

Hence, the correct option is (III)

(b) Constant Growth Rate = 5 %, Required Return = 10 % and Current Dividend = D0 = $ 3

D1 = 3 x 1.13 = $ 3.39 and D2 = 3.39 x 1.13 = $ 3.8307

D3 = 3.8307 x 1.05 = $ 4.022235

Horizon Value = D3 / (Required Return - Constant Growth Rate) = 4.022235 / (0.1 - 0.05) = $ 80.4447 ~ $ 80.44

(c) Intrinsic Value = Present Value of Non-Constant Growth Dividends + Present Value of Horizon Value = [3.39 / 1.1] + [3.8307 / (1.1)^(2)] + [80.4447 / (1.1)^(2)] = $ 72.73091 ~ $ 72.73