Question

9. Nonconstant growth stock Aa Aa 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 $2.40 per share. The company expects the coming year to be very profitable, and its dividend is expected to grow by 20.00% over the next year. After the next year, though, Portman's dividend is expected to grow at a constant rate of 4.00% per year. The risk-free rate (re) is 5.00%, the market risk premium (RPM) is 6.00%, and Portman's beta is 1.00. Assuming that the market is in equilibrium, use the information just given to complete the table. Value Term | Dividends one year from now (D1) Horizon value (P1) Intrinsic value of Portman's stock What is the expected dividend yield for Portman's stock today? О 6.73% О 7.47% О 7.00% О 5.60%

Answer 1

1)

Dividend one year from now = 2.4 * 1.2

Dividend one year from now = 2.88

2)

Required rate = risk free rate + beta (market risk premium)

Required rate = 0.05 + 1 (0.06)

Required rate = 0.11 or 11%

Year 2 dividend = 2.88 * 1.04 = 2.9952

Horizon value = D2 / required rate - growth rate

Horizon value = 2.9952 / 0.11 - 0.04

Horizon value = 42.79

3)

Intrinsic value = 2.88 / (1 + 0.11)¹ + 42.79 / (1 + 0.11)¹

Intrinsic value = 41.14

4)

Dividend yield = (D1 / share price) * 100

Dividend yield = (2.88 / 41.14) * 100

Dividend yield = 7.00%