Problem 94 Nonconstant growth valuation Hart Enterprises rec

Problem 9-4 Nonconstant growth valuation Hart Enterprises recently paid a dividend, DO of $1.00. It expects to have nonconstant growth of 14% for 2 years followed by a constant rate of 4% thereafter. The m s required return is 16% 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. Select- b. What is the firm\'s horizon, or continuing, value? Round your answer to two decimal places c. What is the firm\'s intrinsic value today, Po? Round your answer to two decimal places.

Solution

Answer a.

The terminal, or horizon, date is the date when the growth rate becomes constant. This occurs at the end of Year 2.

Answer b.

D0 = $1.00

Growth rate for next 2 years is 14%, followed by an constant growth rate (g) of 4%

D1 = $1.00 * 1.14 = $1.14
D2 = $1.14 * 1.14 = $1.2996
D3 = $1.2996 * 1.04 = $1.3516

Required return, r = 16%

Horizon Value of Firm = D3 / (r - g)
Horizon Value of Firm = $1.3516 / (0.16 - 0.04)
Horizon Value of Firm = $11.26

Answer c.

Intrinsic Value of Firm = $1.14/1.16 + $1.2996/1.16^2 + $11.26/1.16^2
Intrinsic Value of Firm = $10.32