In: Finance
Nonconstant growth valuation
Holt Enterprises recently paid a dividend, D0, of $3.50. It expects to have nonconstant growth of 23% for 2 years followed by a constant rate of 6% thereafter. The firm's required return is 16%.
(a)-(IV)- The terminal, or horizon, date is the date when the growth rate becomes constant. This occurs at the end of Year 2.
(b)-Firm’s Horizon or Continuing Value
Dividend in Year 0 (D1) = $3.50 per share
Dividend in Year 1 (D1) = $4.3050 [$3.50 x 123%]
Dividend in Year 2 (D2) = $5.2952 per share [$4.3050 x 123%]
Dividend Growth Rate (g) = 6% per year
Required Rate of Return (Ke) = 16%
Firms Horizon or Continuing Value = D2(1 + g) / (Ke – g)
= $5.2952(1 + 0.06) / (0.16 – 0.06)
= $5.6129 / 0.10
= $56.13
“Firm’s Horizon or Continuing Value = $56.13”
(c)-Firms Intrinsic Value Today (P0)
Firms Intrinsic Value Today is the Present Value of the future dividend payments plus the present value of Firm’s Horizon or Continuing Value
Year |
Cash flow ($) |
Present Value factor at 16% |
Stock price ($) |
1 |
4.3050 |
0.86207 |
3.71 |
2 |
5.2952 |
0.74316 |
3.94 |
2 |
56.13 |
0.74316 |
41.71 |
TOTAL |
$49.36 |
||
“Hence, the Firms Intrinsic Value Today (P0) = $49.36”
NOTE
The Formula for calculating the Present Value Factor is [1/(1 + r)n], Where “r” is the Discount/Interest Rate and “n” is the number of years.