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 $2.00000 dividend at that time (D3 $2.00000) and believes that the dividend will grow by 10.40000% 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 3.54000% per year. Goodwin's required return is 11.80000%. 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 Value Term Horizon value Current intrinsic value If investors expect a total return of 12.80%, 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 DY3 and CGY3.) Expected dividend yield (DY3) Expected capital gains yield (CGY2)

Answer 1

Horizon Value = Dividend Year 6/(Required Rate-growth) =D2*(1+growth 1)^2*(1+growth 2)/(r-growth 2)
=2*(1+10.4%)^2*(1+3.54%)/(11.80%-3.54%) =30.5560 or 30.56

Current Intrinsic Value =PV of Dividends + PV of Horizon Value
=2/(1+11.80%)^3+2*(1+10.4%)/(1+11.80%)^4+2*(1+10.4%)^2/(1+11.80%)^5+30.5560/(1+11.80%)^5 =21.73
At r=14%

Horizon Value =Dividend Year 6/(Required Rate-growth) =D0*(1+growth 1)^2*(1+growth 2)/(r-growth 2)
=2*(1+10.4%)^2*(1+3.54%)/(12.80%-3.54%)=27.2562

Price at year 2=D3/(1+r)+D4/(1+r)^2+D5/(1+r)^3+27.2562/(1+r)^3
=2/(1+12.80%)+2*(1+10.4%)/(1+12.80%)^2+2*(1+10.4%)^2/(1+12.80%)^3+27.2562/(1+12.80%)^3=24.20

expected Dividend Yield =2/24.20 =8.27%
Capital Gain = Required Rate - Dividend Yield = 12.8%-8.27% =4.53%