Question

Holt Enterprises recently paid a dividend, D0, of $3.00. It expects to have nonconstant growth of 19% for 2 years followed by a constant rate of 6% thereafter. The firm's required return is 11%.

How far away is the horizon date?

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

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

C)The terminal, or horizon, date is infinity since common stocks do not have a maturity date.

D)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.

E)The terminal, or horizon, date is the date when the growth rate becomes nonconstant. This occurs at time zero.

What is the firm's horizon, or continuing, value? Round your answer to two decimal places. Do not round your intermediate calculations.

$

What is the firm's intrinsic value today, P?0? Round your answer to two decimal places. Do not round your intermediate calculations.

$

Answer 1

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

In case of valuing the stocks, growht rate is taken into consideration to calculate the intrensic value of the comon stock. After super normal growth phase, the growth becomes constant. In the present case, it happens at the end of year 2. As it is mentioned in the problem as non consistant growth ends after 2 years.

2. What is the firm's horizon, or continuing, value?

Given, D₀ = $ 3, g₁= 0.19, g2= 0.06, k = 0.11, g1 period = 2 years, g2 period = from the beginning of 3rd year till inifinity

Formula = D2* (1+g2)/k-g2

= 4.2483 * (1+0.06)/(0.11-0.06)

= 4.5032/0.05

= $ 90.06 (Ans)

3. What is the firm's intrinsic value today, P?0?

Ans: Formula D1(1+g1)/(1+k)1+D2(1+g1)/(1+k)2+ D2 (1+g2)/k-g2

D1= D0(1+g1) = 3 * (1+0.19) = 3.57

PV of D1 = 3.57 * 1/(1+0.11) = 3.1262

D2= D0(1+g1)²= 3 *(1+0.19)²= 4.2483

PV of D2 = 4.2483 * 1/(1+0.11)² = 3.448

Beginning of D3 till Infinity value = D2* (1+g2)/k-g2

= 4.2483 * (1+0.06)/0.11-0.06

= 4.5032/0.05

= $ 90.06

So, now PV of $ 90.06 = 90.06 * 1/(1+1.11)²

= 90.06/1.2321

= 73.5573

So, ultimately the PV of common stock, that is P0 = 3.1262 + 3.448 + 73.5573

P0 = $ 80.13 (Ans)