Question

Holt Enterprises recently paid a dividend, Do, of $3.50. It expects to have nonconstant growth of 15% for 2 years followed by a constant rate of 4% thereafter. The firm's required return is 13%.

a. How far away is the horizon date?
i. The terminal, or horizon, date is the date when the growth rate becomes nonconstant. This occurs at time zero.
ii. The terminal, or horizon, date is the date when the growth rate becomes constant. This occurs at the beginning of Year 2.
iii. The terminal, or horizon, date is the date when the growth rate becomes constant. This occurs at the end of Year 2.
iv. The terminal, or horizon, date is infinity since common stocks do not have a maturity date.
v. 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.
b. What is the firm's horizon, or continuing, value? Do not round intermediate calculations. Round your answer to the nearest cent.
c. What is the firm's intrinsic value today, ? Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

The horizon date for Holt Enterprises occurs at the end of Year 2, as this is when the growth rate becomes constant. The firm's horizon value and intrinsic value today can be calculated through the dividend discount model, considering the respective growth rates and the required rate of return.

Step-by-step explanation:

The question pertains to the valuation of a stock with nonconstant growth using a dividend discount model (DDM). To value Holt Enterprises, we must calculate the dividends during the nonconstant growth phase and find the horizon (also known as the continuing or terminal) value at the point where the growth becomes constant. The horizon date is the end of Year 2, which corresponds to option iii, as the nonconstant growth of 15% is for 2 years after which a perpetual growth rate of 4% will be applied.

Firm's Horizon Value Calculation

Using the Gordon Growth Model, the horizon value at the end of Year 2 can be calculated taking the dividend at Year 3 (which will grow perpetually at 4% thereafter) and dividing it by the difference between the required return of 13% and the perpetual growth rate of 4%.

Firm's Intrinsic Value Today Calculation

The intrinsic value of the firm today is the sum of the present values of all future expected dividends, including the present value of the horizon value. The different dividends at different time periods should be discounted back to the present using the required return rate of 13%. The present value of future dividends during the initial 2 years of nonconstant growth, plus the present value of the horizon value, gives us the firm's intrinsic value today. Unfortunately, without including the complete workings of the formulas and calculations, the exact intrinsic values cannot be provided.