Question

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 $5.00000 dividend at that time (D₃ = $5.00000) and believes that the dividend will grow by 26.00000% for the following two years (D₄ and D₅). However, after the fifth year, she expects Goodwin’s dividend to grow at a constant rate of 4.26000% per year.

Goodwin’s required return is 14.20000%. 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, do not round your intermediate calculations, but round all final answers to two decimal places.

Term	Value
Horizon value
Current intrinsic value

Assuming that the markets are in equilibrium, Goodwin’s current expected dividend yield is ______, and Goodwin’s capital gains yield is ______.

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 has a large selection of profitable investment opportunities.

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

(No/Yes)

Answer 1

Given about Goodwin Technologies,

Goodwin to begin paying dividends, beginning with a dividend of $5.00 coming 3 years from today

So, D3 = $5.00

growth rate for next 2 year = 26.00%

So, D4 = D3*1.26 = 5*1.26 = $6.30

D5 = D4*1.40 = 6.30*1.26 = $7.938

thereafter growth rate g = 4.26%

required return on Goodwin rs = 14.2%

So, Horizon value price of stock at year 5 using constant dividend growth model is

Horizon value P5 = D5*(1+g)/(rs-g) = 7.938*(1.0426)/(0.142-0.0426) = $83.2612

So, horizon value = $83.2612

So, current price of stock today is sum of PV of future dividends and P5 discounted at rs

P0 = D3/(1+rs)^3 + D4/(1+rs)^4 + D5/(1+rs)^5 + P5/(1+rs)^5

P0 = 5/1.142^3 + 6.3/1.142^4 + 7.938/1.142^5 + 83.2612/1.142^5 = $54.01

current intrinsic value = $54.01

current dividend yield DY = D1/P0 = 0/54.01 = 0

Current capital gain yield = rs - DY = 14.2-0 = 14.20%

Investors prefer the deferred tax liability that capital gains offer over dividends. This statement is true, and tax on capital gain is only paid when the stock is sold. So it is deferred tax till actual sale of the stock.