Question

Question 708 Check My Work (1 remaining) Problem 9-4 Nonconstant growth valuation Holt Enterprises recently paid a dividend, Do, of $4.00. It expects to have nonconstant growth of 15% for 2 years followed by a constant rate of 10 thereafter. The firm's required return is 13%. a. 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. II. The terminal, or horizon, date is the date when the growth rate becomes constant. This occurs at the beginning of Year 2. III. The terminal, or horizon, date is the date when the growth rate becomes constant. This occurs at the end of Year 2. IV. The terminal, or horizon, date is infinity since common stocks do not have a maturity date. V. The terminal, or horizon, date is Year since the value of a common stock is the present value of all future expected dividends at time rero -Select- b. What is the firm's horizon, or continuing, value? Round your answer to two decimal places. Do not round your intermediate calculations. c. What is the firm's intrinsic value today, Po? Round your answer to two decimal places. Do not round your intermediate calculations. Check My Work (1 remaining)

Answer 1

Since two questions are asked, as HOMEWORKLIB's policy only the first question is answered.

Part a.

Option 3 is correct. Horizon date is the date when the growth rate becomes constant. This occurs at the end of year 2. For the first two years the growth rate is different. The constant growth starts at the end of year 2 or beginning of year 3.

Part b.

Firm's horizon value = value of the firm at the horizon date. This is calculated by using Gordon's constant growth model

Horizon value = D1 /(r-g) where D1 is the dividend at the end of year 1 after the horizon date.

r = 13%

g = 10%

Let us calculate D1 now.

D0 is the recent dividend = 4.00. This grows for 2 years at the rate of 15% till the horizon date.

Dividend at the horizon date = 4*(1+15%)*(1+15%) = 5.29

Dividend at the end of year 1 after the horizon date = Dividend at horizon date * (1+10%) = 5.29*(1+10%) = 5.819

Now substitute this in the horizon value formula above:

Horizon value = D1 /(r-g) = 5.819/(13%-10%) = $193.97

Firm's Horizon value = $193.97

Part c:

Firm's intrinsic value today is the present value of all the dividends paid.

Firm's intrinsic value = PV (dividends paid for first 2 years) + PV (dividends paid after horizon date)

= PV (discount dividend paid for each year by the firm's required return of 13%) + PV (Horizon value calculated earlier)

= 4*(1+15%)/(1+13%) + 4*(1+15%)*(1+15%)/(1+13%)² +  193.97/(1+13%)² = $160.12

Firm's intrinsic value = $160.12