Question

Holt Enterprises recently paid a dividend, D₀, of $3.75. It expects to have nonconstant growth of 21% for 2 years followed by a constant rate of 4% thereafter. The firm's required return is 19%.

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.

What is the firm's horizon, or continuing, value? Do not round intermediate calculations. Round your answer to the nearest cent.

What is the firm's intrinsic value today, P0 ? Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

1.

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

2.

Horizon Value = D_i+1/(r - g)

D₀ = $3.75

D₁ = 3.75(1.21) = $4.54

D₂ = 3.75(1.21)² = $5.49

D₃ = 5.49(1.04) = $5.71

So,

Horizon Value = 5.71/(0.19 - 0.04)

Horizon Value = $38.07

3.

Intrinsic Value = PV(Dividends) + PV(Horizon Value)

Intrinsic Value = 4.54/(1.19) + 5.49/(1.19)² + 38.07/(1.19)²

Intrinsic Value = 3.82 + 3.87 + 26.88

Intrinsic Value = $34.57