Question

8. Nonconstant growth stock 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 $3.12 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 Assuming that the market is in equilibrium, use the information just given to complete the table. Term Value Dividends one year from now (D1) Horizon value (P1) Intrinsic value of Portman's stock The risk-free rate (rRF) is 3.00%, the market risk premium (RPM) is 3.60%, and Portman's beta is 1.10. What is the expected dividend yield for Portman's stock today? 4,46% 3.65% 4.77% 4.56%

Answer 1

Required rate of return as per CAPM = Risk free rate + beta*Market risk premium

= 3% + 1.10*3.60%

= 6.96%

Dividend one year from now = Current Dividend*(1+growth rate)

= 3.12(1.12) = $3.4944

Horizon value = Dividend in year 2/(Required return – growth rate)

= 3.4944(1+2.40%)/(6.96%-2.4%)

= $78.47

Intrinsic Value = (3.4944+78.47)/(1.0696)

= $76.63

Dividend yield = Expected Dividend/Current Price

= 3.4944/76.63

= 4.56%