Question

Goodwin Technologies, a relatively young company, has been wildly successful but has yet to pay a dividend. An analyst forecasts that Goodwin is likely to pay its first dividend three years from now. She expects Goodwin to pay a $1.25000 dividend at that time (D₃ = $1.25000) and believes that the dividend will grow by 6.50000% for the following two years (D₄ and D₅). However, after the fifth year, she expects Goodwin’s dividend to grow at a constant rate of 3.36000% per year.

Goodwin’s required return is 11.20000%. Fill in the following chart to determine Goodwin’s horizon value at the horizon date (when constant growth begins) and the current intrinsic value. To increase the accuracy of your calculations, do not round your intermediate calculations, but round all final answers to two decimal places.

Term Value
Horizon Value __________
Current Intrinsic value __________

Assuming that the markets are in equilibrium, Goodwin's current expected dividend yield is ___________, and Goodwin's capital gains yield is _______

Answer 1

A. Term Value

Horizon Value $18.69

Current Intrinsic value $13.61

B. Dividend yield 0%

Capital gains yield 11.20%

Step-by-step explanation:

A. Calculation to determine Horizon Value

Using this formula

Horizon Value = Dividend in Year 6/(Required Return – Growth Rate)

Let plug in the formula

Horizon Value = 1.25(1.0650)^2 (1.0336)/(11.20%-3.36%)

Horizon Value = $18.69

Calculation to determine the Current Intrinsic value Using this formula

Current intrinsic value = 1.25/(1.1120)^3 + 1.25(1.0650)/(1.1120)^4 + 1.25(1.0650)^2/(1.1120)^5 + 18.69/(1.1120)^5

Current intrinsic value = $13.61

B. Calculation to determine Dividend yield

Using this formula

Dividend yield = Expected Dividend next year/Current price

Let plug in the formula

Dividend yield= 0/13.61

Dividend yield= 0%

Calculation to determine Expected Capital Gains Yield using this formula

Expected Capital Gains Yield = Required return - Expected Current Dividend Yield

Let plug in the formula

Expected Capital Gains Yield= 11.20%- 0%

Expected Capital Gains Yield= 11.20%

Therefore:

Term Value

Horizon Value $18.69

Current Intrinsic value $13.61

Therefore Assuming that the markets are in equilibrium, Goodwin's current expected dividend yield is 0% and Goodwin's capital gains yield is 11.20%