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 $2.5000 dividend at that time (D3D3 = $2.5000) and believes that the dividend will grow by 13.00% for the following two years (D4D4 and D5D5). However, after the fifth year, she expects Goodwin’s dividend to grow at a constant rate of 3.66% per year.

Goodwin’s required return is 12.20%. 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, carry the dividend values to four decimal places.

Term	Value
Horizon value
Current Intrinsic value

If investors expect a total return of 13.20%, 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 DY3DY3 and CGY3CGY3.)

Expected dividend yield (DY3DY3)
Expected capital gains yield (CGY3CGY3)

Goodwin has been very successful, but it hasn’t paid a dividend yet. It circulates a report to its key investors containing the following statement:

Goodwin’s investment opportunities are poor.

Is this statement a possible explanation for why the firm hasn’t paid a dividend yet?

Yes

No

Answer 1

Goodwin’s required return is 12.20%. 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, carry the dividend values to four decimal places.

Term	Value
Horizon value	$38.7481
Current Intrinsic value	$27.1393

Horizon value = Dividend in year 5 * (1 + Constant Growth Rate) / (Required rate - Constant Growth rate)

If investors expect a total return of 13.20%, 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 DY3DY3 and CGY3CGY3.)

Dividend Yield = Dividend in year 3 / Stock Price at year 2 = $2.5000 / 31.2896 = 7.9899%

Capital gain Yield = Required rate - Dividend yield = 13.20%-7.9899% = 5.2101%

Goodwin has been very successful, but it hasn’t paid a dividend yet. It circulates a report to its key investors containing the following statement:

Goodwin’s investment opportunities are poor.

Is this statement a possible explanation for why the firm hasn’t paid a dividend yet?

No, because when there are no investment opportunities then the company should pay off the earnings available so that the investor might find a better investment opportunity