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eBook Problem Walk-Through Holt Enterprises recently paid a dividend, D0, of $1.75. It expects to have...

eBook Problem Walk-Through

Holt Enterprises recently paid a dividend, D0, of $1.75. It expects to have nonconstant growth of 14% for 2 years followed by a constant rate of 4% thereafter. The firm's required return is 8%.

  1. How far away is the horizon date?
    1. The terminal, or horizon, date is Year 0 since the value of a common stock is the present value of all future expected dividends at time zero.
    2. The terminal, or horizon, date is the date when the growth rate becomes nonconstant. This occurs at time zero.
    3. The terminal, or horizon, date is the date when the growth rate becomes constant. This occurs at the beginning of Year 2.
    4. The terminal, or horizon, date is the date when the growth rate becomes constant. This occurs at the end of Year 2.
    5. The terminal, or horizon, date is infinity since common stocks do not have a maturity date.

  2. What is the firm's horizon, or continuing, value? Do not round intermediate calculations. Round your answer to the nearest cent.

    $  

  3. What is the firm's intrinsic value today, ? Do not round intermediate calculations. Round your answer to the nearest cent.

    $  

Solutions

Expert Solution

(a)-(IV)- The terminal, or horizon, date is the date when the growth rate becomes constant. This occurs at the end of Year 2.

(b)-Firm’s Horizon or Continuing Value

Dividend in Year 0 (D1) = $1.75 per share

Dividend in Year 1 (D1) = $1.9950 per share [$1.75 x 114%]

Dividend in Year 2 (D2) = $2.2743 per share [$1.9950 x 114%]

Dividend Growth Rate (g) = 4.00% per year

Required Rate of Return (Ke) = 8.00%

Firms Horizon or Continuing Value = D2(1 + g) / (Ke – g)

= $2.2743(1 + 0.04) / (0.08 – 0.04)

= $2.3653 / 0.04

= $59.13 per share

“Firm’s Horizon or Continuing Value = $59.13”

(c)-Firms Intrinsic Value Today (P0)

Firms Intrinsic Value Today is the Present Value of the future dividend payments plus the present value of Firm’s Horizon or Continuing Value

Year

Cash flow ($)

Present Value factor at 8.00%

Stock price ($)

1

1.9950

0.92593

1.84

2

2.2743

0.85734

1.95

2

59.13

0.85734

50.70

TOTAL

54.49

“Hence, the Firms Intrinsic Value Today (P0) = $54.49”

NOTE

The Formula for calculating the Present Value Factor is [1/(1 + r)n], Where “r” is the Discount/Interest Rate and “n” is the number of years.

jeff jeffy answered 7 months ago
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