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 $2.00000 dividend at that time (D₃ = $2.00000) and believes that the dividend will grow by 10.40000% 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 3.54000% per year. Goodwin’s required return is 11.80000%. 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 If investors expect a total return of 12.80%, 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 DY₃ and CGY₃.) Expected dividend yield (DY₃)    Expected capital gains yield (CGY₃)    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

ans a	Computation of horizon value at the end of 5 year = Dividend for 6th year / (required rate - growth rate)
		year	dividend
		3	$     2.00
		4	$     2.21
		5	$     2.44
		6	$     2.52
	therefore horizon value =
				$   30.56
				2.52/(11.8%-3.54%)
ans b	Current intrensic value = Present value of future cash flow @ 11.8% rate of return
			i	ii	iii=i+ii	iv	v
		year	dividend	horizon value	Total cash flow	PVIF @ 11.8%	present value
		3	$     2.00		$       2.00	0.715607	$                              1.43
		4	$     2.21		$       2.21	0.640078	$                              1.41
		5	$     2.44	30.56	$     32.99	0.57252	$                            18.89
							$                            21.72
	therefore intrensic value=				$                            21.72
ans c	DY 3 =	Expected dividend at the end of year 3/Price at the beginning of year 3
		Price in beginning of year - 3
			i	ii	iii=i+ii	iv	v
		year	dividend	horizon value	Total cash flow	PVIF @ 12.8%	present value
		3	$     2.00		$       2.00	0.886525	$                              1.77
		4	$     2.21		$       2.21	0.785926	$                              1.74
		5	$     2.44	27.26	$     29.69	0.696743	$                            20.69
							$                            24.20
		Terminal value =
			=2.44*103.54%/(12.8%-3.54%)	27.26
		therefore DY 3 = 2/24.2 =			8.27%
		CGY 3 = 12.8%-8.27%				4.53%
ans d	Correct answer is option : YES