Question

Church Inc. is presently enjoying relatively high growth because of a surge in the demand for its new product. Management expects earnings and dividends to grow at a rate of 3.4% for the next 4 years, after which competition will probably reduce the growth rate in earnings and dividends to zero, i.e., g = 0. The company’s most recent dividend, D₀, was $1.68, and its required rate of return is 12%. What is the expected Horizon Value at t=4? And what is the current price of the common stock? (please show work)

Answer 1

Step 1: Computation of market price at the end of year 4

Using Gordon Growth Model

Horizon Value = P4 = D5 / (Ke – g)

Where,

P4 - Market price at the end of year 4 =?

D5 - Expected dividend in year 5 = 1.68*1.034^4 = 1.92039884792

Ke – Cost of equity = 12%

G – Growth rate in dividend = 0

P4 = 1.92039884792/(.12-0)

= 16.0033237327

= 16

Step 2: Computing current share price by discounting the cashflow at required return

Year	Dividend	PVF@12%	Present Value (Cashflow*PVF)
1	1.7371	0.893	1.55
2	1.7962	0.797	1.43
3	1.8573	0.712	1.32
4	17.9204 (1.8573*1.034+16)	0.636	11.39

current share price = Cashflow*PVF

= 1.55+1.43+1.32+11.39

= 15.69

You can use the equation (1-(1+r)^-n)/r to find PVF using calculator