Question

Holt Enterprises recently paid a dividend, D₀, of $1.50. It expects to have nonconstant growth of 22% for 2 years followed by a constant rate of 7% thereafter. The firm's required return is 8%.

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

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

b. The horizon value is computed as shown below:

= Dividend in year 3 / (rate of return - growth rate)

= (D0 x 1.22² x 1.07) / ( 0.08 - 0.07)

= ($ 1.50 x 1.22² x 1.07) / 0.01

= $ 238.8882 or $ 238.89 Approximately

c. The value is computed as shown below:

= Dividend in year 1 / (1 + rate of return) +  Dividend in year 2 / (1 + rate of return)² +  Horizon value / (1 + rate of return)²   

= ($ 1.50 x 1.22) / 1.08 + ($ 1.50 x 1.22²) / 1.08² + $ 238.8882 / 1.08²

= $ 1.83 / 1.08 + $ 2.2326 / 1.08² + $ 238.8882 / 1.08²

= $ 208.42 Approximately

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