Question

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 7% thereafter. The firm's required return is 8%.

1. How far away is the horizon date?
   1. The terminal, or horizon, date is the date when the growth rate becomes constant. This occurs at the beginning of Year 2.
   2. The terminal, or horizon, date is the date when the growth rate becomes constant. This occurs at the end of Year 2.
   3. The terminal, or horizon, date is infinity since common stocks do not have a maturity date.
   4. 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.
   5. The terminal, or horizon, date is the date when the growth rate becomes nonconstant. This occurs at time zero.
   
   -Select-IIIIIIIVVItem 1
   
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.

   $  

Answer 1

a. The horizon value reflects the value at the date when the growth rate becomes constant. The terminal, or horizon, date is the date when the growth rate becomes constant. This occurs at the end of Year 2.

So, the correct answer is option II.

b. The horizon value is computed as shown below:

= [ Current dividend (1 + growth rate for first 2 years)² x (1 + constant growth rate) ] / ( required return - growth rate)

= [ $ 1.75 x 1.14² x 1.07 ] / ( 0.08 - 0.07 )

= $ 2.433501 / 0.01

= $ 243.35 Approximately

c. The firm's intrinsic value is computed as shown below:

= Dividend in year 1 / ( 1 + required rate of return)¹ + Dividend in year 2 / ( 1 + required rate of return)² + 1 / ( 1 + required rate of return)² [ ( Dividend in year 2 (1 + growth rate) / ( required rate of return - growth rate) ]

= ($ 1.75 x 1.14) / 1.08 + ($ 1.75 x 1.14²) / 1.08² + 1 / 1.08² [ [ $ 1.75 x 1.14² x 1.07 ] / ( 0.08 - 0.07 ) ]

= $ 1.995 / 1.08 + $ 2.2743 / 1.08² + 1 / 1.08² [ $ 243.3501 ]

= $ 1.995 / 1.08 + $ 245.6244 / 1.08²

= $ 212.43 Approximately

Please ask in case of any doubts