As companies evolve, certain factors can drive sudden growth. This may lead to a period of nonconstant, or variable, growth. This would cause the expected growth rate to increase or decrease, thereby affecting the valuation model. For companies in such situations, you would refer to the variable, or nonconstant, growth model for the valuation of the company’s stock.
Consider the case of Portman Industries:
Portman Industries just paid a dividend of $1.92 per share. The company expects the coming year to be very profitable, and its dividend is expected to grow by 12.00% over the next year. After the next year, though, Portman’s dividend is expected to grow at a constant rate of 2.40% per year.
Term |
Value |
---|---|
Dividends one year from now (D1D1) | |
Horizon value (P̂1P̂1) | |
Intrinsic value of Portman’s stock |
The risk-free rate (rRFrRF) is 3.00%, the market risk premium (RPMRPM) is 3.60%, and Portman’s beta is 1.80.
Assuming that the market is in equilibrium, use the information just given to complete the table.
What is the expected dividend yield for Portman’s stock today?
6.91%
7.57%
5.66%
7.08%
Required Return, rs = Risk-free Rate + Beta * Market Risk
Premium
Required Return, rs = 3.00% + 1.80 * 3.60%
Required Return, rs = 9.48%
Last Dividend, D0 = $1.92
Growth rate for next year is 12.00% and a constant growth rate (g) of 2.40% thereafter.
Dividends one year from now, D1 = $1.92 * 1.12
Dividends one year from now, D1 = $2.1504
Dividends two year from now, D2 = $2.1504 * 1.024
Dividends two year from now, D2 = $2.2020096
Horizon Value, P1 = D2 / (rs - g)
Horizon Value, P1 = $2.2020096 / (0.0948 - 0.024)
Horizon Value, P1 = $31.1018
Intrinsic Value, P0 = $2.1504 / 1.0948 + $31.1018 / 1.0948
Intrinsic Value, P0 = $30.37
Dividend Yield = D1 / P0
Dividend Yield = $2.1504 / $30.37
Dividend Yield = 0.0708 or 7.08%
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