Question

Goodwin Technologies, a relatively young company, has been wildly successful but has yet to pay a dividend. An analyst forecasts that Goodwin is likely to pay its first dividend three years from now. She expects Goodwin to pay a $2.50000 dividend at that time (D₃ = $2.50000) and believes that the dividend will grow by 13.00000% for the following two years (D₄ and D₅). However, after the fifth year, she expects Goodwin’s dividend to grow at a constant rate of 3.66000% per year.

Goodwin’s required return is 12.20000%. Fill in the following chart to determine Goodwin’s horizon value at the horizon date (when constant growth begins) and the current intrinsic value. To increase the accuracy of your calculations, do not round your intermediate calculations, but round all final answers to two decimal places.

Term

Value

Horizon value

Current intrinsic value

If investors expect a total return of 13.20%, what will be Goodwin’s expected dividend and capital gains yield in two years—that is, the year before the firm begins paying dividends? Again, remember to carry out the dividend values to four decimal places. (Hint: You are at year 2, and the first dividend is expected to be paid at the end of the year. Find DY₃ and CGY₃.)

Expected dividend yield (DY₃)

Expected capital gains yield (CGY₃)

Goodwin has been very successful, but it hasn’t paid a dividend yet. It circulates a report to its key investors containing the following statement:

Goodwin has a large selection of profitable investment opportunities.

Is this statement a possible explanation for why the firm hasn’t paid a dividend yet?

No

Yes

Answer 1

Year	Dividend C/f		PV F at 12.2%	PV at 12.2%
0			1	0
1			0.89127	0
2			0.79435	0
3	2.5	2.5	0.70798	1.7700
4	2.5*1.13^1=	2.825	0.63100	1.7826
5	2.5*1.13^2=	3.19225	0.56239	1.7953
5	3.19225*1.0366/(12.2%-3.66%)=	38.7481	0.56239	21.7914
				27.1392
So,
Answers from the above,
Goodwin’s horizon value at the horizon date (when constant growth begins)
3.19225*1.0366/(12.2%-3.66%)= 38.74808 ,ie $ .38.75
&
the current intrinsic value= sum of the Discounted value of the cash flows=
27.14

	2…At 13.2% required return
			To find P0		To find P2			To find P3
Year	Dividend C/f		PV F at 13.2%	PV at 13.2%		PV F at 13.2%	PV at 13.2%		PV F at 13.2%	PV at 13.2%
0			1	0
1			0.88339	0
2			0.78038	0
3	2.5	2.5	0.68938	1.7235	2.5	0.88339	2.2085
4	2.5*1.13^1=	2.825	0.60900	1.7204	2.825	0.78038	2.2046	2.825	0.88339	2.49558304
5	2.5*1.13^2=	3.1923	0.53798	1.7174	3.1923	0.68938	2.2007	3.1923	0.78038	2.49117388
5	3.19225*1.0366/(13.2%-3.66%)=	34.6864	0.53798	18.6607	34.68644	0.68938	23.9123	34.68644	0.78038	27.0686671
			P0=	23.8219		P2=	30.5260		P3=	32.0554

Expected dividend yield (DY₃)

D3/Intrinsic value of stock at end year 2

2.5/30.5260=

8.19%

OR can also be calculated as

D3/Yr. 0 Intrinsic value of stock *1.132^2

ie.2.5/(23.8219*1.132^2)=

8.19%

Expected capital gains yield (CGY₃)

Here P3= from the table 32.0554

Or can be calculated as

(30.526*1.132^1)-2.5(div.paid)= 32.0554

Now

CGY(3)=

(P3-P0)/P0

(32.0554-23.8219)/23.8219=

34.56%