Question

Holt Enterprises recently paid a dividend, D₀, of $2.50. It expects to have nonconstant growth of 23% for 2 years followed by a constant rate of 5% thereafter. The firm's required return is 14%.

a. How far away is the horizon date?
I. The terminal, or horizon, date is infinity since common stocks do not have a maturity date.
II. 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.
III. The terminal, or horizon, date is the date when the growth rate becomes nonconstant. This occurs at time zero.
IV. The terminal, or horizon, date is the date when the growth rate becomes constant. This occurs at the beginning of Year 2.
V. The terminal, or horizon, date is the date when the growth rate becomes constant. This occurs at the end of Year 2.
b. What is the firm's horizon, or continuing, value? Do not round your intermediate calculations.
c. What is the firm's intrinsic value today, P₀? Do not round your intermediate calculations.

Answer 1

The horizon date for Holt Enterprises' stock is at the end of Year 2, which is when the growth rate becomes constant. The horizon value is calculated using the formula for present value of a perpetuity with growth, and the intrinsic value today is the sum of the present values of all expected dividends, including the constant growth period beyond Year 2.

Step-by-step explanation:

The student's question pertains to the calculation of the horizon date and the intrinsic value of Holt Enterprises' stock, given its expected dividend payments and growth rates. The horizon date, in financial terms, refers to the point in time after which the growth rate of dividends is expected to remain constant indefinitely. In this case, the correct answer is V. which indicates that the terminal, or horizon, date is the date when the growth rate becomes constant, occurring at the end of Year 2. For the horizon value, or continuing value, we calculate it at the point where the growth rate becomes constant.

The present value of the terminal value, which reflects all future dividends after the nonconstant growth period, is calculated using the constant growth formula: PV = D1 / (r - g), where D1 is the dividend at the end of the first stage of growth, r is the required return, and g is the long-term constant growth rate. The intrinsic value of the firm today (P₀) is the sum of the present value of the dividends during the nonconstant growth period and the present value of the terminal value. The calculation involves discounting the expected dividends in Year 1 and Year 2 by the required return of 14%, followed by adding the present value of the terminal value calculated at the end of Year 2. This calculation requires careful consideration of time value of money principles and an understanding of dividend growth models.