Question

9. Stocks that don't pay dividends yet 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 $3.75000 dividend at that time (D3 = $3.75000) and believes that the dividend will grow by 19.50000% for the following two years (D4 and Ds). However, after the fifth year, she expects Goodwin's dividend to grow at a constant rate of 3.96000% per year. Goodwin's required return is 13.20000%. 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 14.20%, 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 DY: and CGY3.) Expected dividend yield (DY) Expected capital gains yield (CGY)

Answer 1

D6 =D3*(1+Growth1)^2*(1+Growth2) =3.75*(1+19.5%)^2*(1+3.96%)
Terminal value =D6/(Required rate-growth) =3.75*(1+19.5%)^2*(1+3.96%)/(13.2%-3.96%) =60.2506 or 60.25

D3=3.75
D4=3.75*(1+19.5%)
D5=3.75*(1+19.5%)^2
Intrinsic Value =D3/(1+r)^3+D4/(1+r)^4+D5/(1+r)^5+Terminal Value/(1+r)^5
=3.75/(1+13.2%)^3+3.75*(1+19.5%)/(1+13.2%)^4+3.75*(1+19.5%)^2/(1+13.2%)^5+60.2506/(1+13.2%)^5 =40.61


If required rate is 14.2%
Terminal value =D6/(Required rate-growth) =3.75*(1+19.5%)^2*(1+3.96%)/(14.2%-3.96%) =54.3668
Price in Year 2 =D3/(1+r)+D4/(1+r)^2+D5/(1+r)^3+Terminal Value/(1+r)^3
=3.75/(1+14.2%)+3.75*(1+19.5%)/(1+14.2%)^2+3.75*(1+19.5%)^2/(1+14.2%)^3+54.3668 /(1+14.2%)^3=46.8190
Expected dividend yield =3.75/46.8190 =8.01%
Capital Gain Yield =Required Rate-Dividend Yield =14.2%-8.01% =6.19%