Question

Holt Enterprises recently paid a dividend, D₀, of $1.25. It expects to have nonconstant growth of 21% for 2 years followed by a constant rate of 6% thereafter. The firm's required return is 16%.

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.
   
   
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

Part (a):

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

The answer is option II.

Part (b):

Firms’ horizon or continuing value is the PV of Dividend for year 3 onwards (at the constant growth rate)

Continuing value= D₃/r-g₃

Where D₃= Dividend for year 3, r= required rate of return (given as 16%) and g₃= constant growth rate after year 2 (given as 6%)

Given, D₀= $1,25 and growth rate for years 1 and 2 (g₂)is 21%.

Therefore, D₃= 1.25*(1+21%)^2*(1+6%)= $1.939933

Substituting these values, Continuing value= $1.939933/(0.16-0.06) = $19.40

Part (c):

Intrinsic value today= $17.08

Calculation as follows: