Question

Holt Enterprises recently paid a dividend, D₀, of $2.00. It expects to have nonconstant growth of 24% for 2 years followed by a constant rate of 4% thereafter. The firm's required return is 17%.

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

Answer a.

The terminal, or horizon, date is the date when the growth rate becomes constant. This occurs at the end of Year 2.

Answer b.

D0 = $2.00

Growth rate for next 2 years is 24% and a constant growth rate (g) of 4%

D1 = $2.00 * 1.24 = $2.48
D2 = $2.48 * 1.24 = $3.0752
D3 = $3.0752 * 1.04 = $3.1982

Required return, rs = 17%

Horizon Value, P2 = D3 / (rs - g)
Horizon Value, P2 = $3.1982 / (0.17 - 0.04)
Horizon Value, P2 = $24.60

Answer c.

Intrinsic Value, P0 = $2.48/1.17 + $3.0752/1.17^2 + $24.60/1.17^2
Intrinsic Value, P0 = $22.34