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Nonconstant growth valuation Holt Enterprises recently paid a dividend, D0, of $2.00. It expects to have...

Nonconstant growth valuation

Holt Enterprises recently paid a dividend, D₀, of $2.00. It expects to have nonconstant growth of 13% for 2 years followed by a constant rate of 6% thereafter. The firm's required return is 20%.

How far away is the horizon date?
1. The terminal, or horizon, date is the date when the growth rate becomes constant. This occurs at the beginning of Year 2.
2. The terminal, or horizon, date is the date when the growth rate becomes constant. This occurs at the end of Year 2.
3. The terminal, or horizon, date is infinity since common stocks do not have a maturity date.
4. 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.
5. 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, P₀? Round your answer to two decimal places. Do not round your intermediate calculations.

Expert Solution

(a)-(II) 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 1 (D1) = $2.2600 per share [$2.00 x 113%]

Dividend in Year 2 (D2) = $2.5538 per share [$2.2600 x 113%]

Dividend Growth Rate (g) = 6%

Required Rate of Return (Ke) = 20%

Firms Horizon or Continuing Value = D2(1 + g) / (Ke – g)

= $2.5538(1 + 0.06) / (0.20 – 0.06)

= $2.7070 / 0.14

= $19.34

“Firm’s Horizon or Continuing Value = $19.34”

(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 ($)	Present Value factor at 20%	Stock price ($)

1	2.2600	0.83333	1.88
2	2.5538	0.69444	1.77
2	19.34	0.69444	13.43

TOTAL			$17.08

“Hence, the Firms Intrinsic Value Today (P0) = $17.08”

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.

jeff jeffy answered 1 year ago

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