Question

Holt Enterprises recently paid a dividend, D0, of $2.25. It expects to have nonconstant growth of 20% for 2 years followed by a constant rate of 8% thereafter. The firm's required return is 19%.

How far away is the horizon date?
a. The terminal, or horizon, date is the date when the growth rate becomes nonconstant. This occurs at time zero.
b. The terminal, or horizon, date is the date when the growth rate becomes constant. This occurs at the beginning of Year 2.
c. The terminal, or horizon, date is the date when the growth rate becomes constant. This occurs at the end of Year 2.
d. The terminal, or horizon, date is infinity since common stocks do not have a maturity date.
e. 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.

Answer 1

The terminal or horizon date for Holt Enterprises is at the end of Year 2, which is when the dividend growth rate becomes constant at 8% following two years of 20% nonconstant growth.

Step-by-step explanation:

The question pertains to the valuation of Holt Enterprises' stock and specifically requires the identification of the terminal or horizon date, which is the point in time when the growth rate of dividends becomes constant. The correct answer is: c. The terminal, or horizon, date is the date when the growth rate becomes constant. This occurs at the end of Year 2. Holt Enterprises expects nonconstant growth of 20% for 2 years. Therefore, the horizon date is not at time zero, nor is it at the beginning of Year 2. Instead, it is after two years of this nonconstant growth that the firm expects to shift to a steady growth rate of 8%. At the end of Year 2, the dividends will start growing at this constant rate indefinitely. Option d is incorrect as well, as the terminal date in a stock valuation model refers to the point when growth becomes constant, not to the indefinite nature of the stock's life. Option e is also incorrect because the value of a common stock considers the present value of all future dividends, but the terminal date refers specifically to the transition to constant growth rather than to the valuation exercise.