Question

NONCONSTANT GROWTH VALUATION

Holt Enterprises recently paid a dividend, D₀, of $3.25. It expects to have nonconstant growth of 14% for 2 years followed by a constant rate of 7% thereafter. The firm's required return is 12%.

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

b)

Year 1 dividend = 3.25 * 1.14 = 3.705

Year 2 dividend = 3.705 * 1.14 = 4.2237

Year 3 dividend = 4.2237 * 1.07 = 4.519359

Horizon value = D3 / required rate - growth rate

Horizon value = 4.519359 / 0.12 - 0.07

Horizon value = 4.519359 / 0.05

Horizon value = $90.39

c)

Intrinsic value = 3.705 / (1 + 0.12)¹ + 4.2237 / (1 + 0.12)² + 90.39 / (1 + 0.12)²

Intrinsic value = $78.73