Question

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NONCONSTANT GROWTH VALUATION

Holt Enterprises recently paid a dividend, D₀, of $1.00. It expects to have nonconstant growth of 25% for 2 years followed by a constant rate of 3% thereafter. The firm's required return is 20%.

1. How far away is the horizon date?
   1. The terminal, or horizon, date is the date when the growth rate becomes constant. This occurs at the end of Year 2.
   2. The terminal, or horizon, date is infinity since common stocks do not have a maturity date.
   3. 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.
   4. The terminal, or horizon, date is the date when the growth rate becomes nonconstant. This occurs at time zero.
   5. The terminal, or horizon, date is the date when the growth rate becomes constant. This occurs at the beginning of Year 2.
   
   -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

- Dividend just paid (D0) = $1.00

Growth rate for 2 years(g) = 25%

Growth rate thereafter(g1) = 3%

Required rate of Return(Ke) = 20%

D1 = D0(1+g) =$1.00(1+0.25)

= $1.25

D2 = D1(1+g) = $1.25*(1+0.25)

= $1.5625

a). Horizon date is the date when the Growth rate becomes Constant. It occurs at the end of year 2.

Hence, Option I

b). Calculating the Firm's Horizon value:-

HV = $9.4669

So, Horizon Value is $9.47 per share

b). Calculating the Firm's Intrinsic Value:-

Price = $1.0417 + $1.0851 + $6.5742

Price = $8.70

So, Firm's intrinsic Value = $8.70

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