6 Nonconstant growth stock Aa Aa As companies evolve certain

6. Nonconstant growth stock Aa Aa As companies evolve, certain factors can drive sudden growth. This may lead to a period of nonconstant, or variable growth. This would cause the expected growth rate to increase or decrease, thereby affecting the valuation model For companies in such situations, you would refer to the variable, or nonconstant, growth model for the valuation of the company\'s stock Consider the case of Portman Industries: Portman Industries just paid a dividend of $2.64 per share. The company expects the coming year to be very profitable, and its dividend is expected to grow by 12.00% over the next year. After the next year, though, Portman\'s dividend is expected to grow at a constant rate of 2.40% per year. The risk-free rate (Rr) is 3.00%, the market risk premium (RPM) is 3.60%, and Portman\'s beta is 0.90 Term Value Dividends one year from now (D1)$2.9568 Horizon value (P1) Intrinsic value of Portman\'s stock Assuming that the market is in equilibrium, use the information just given to complete the table What is the expected dividend yield for Portman\'s stock today? ? 3.98% ? 3.84% 3.75% 3.07%

Solution

Required rate of return = 3% + (3.60% × 0.90)

= 3% + 3.24%

= 6.24%

Required rate of return is 6.24%.

1.

Dividend one year from Now = $2.64 × (1 + 12%)

= $2.9568

Dividend one year from now $2.9568.

Horizon value = $2.9568 × (1 + 2.40%) / (6.24% - 2.40%)

= $3.028 / 3.84%

= $78.85

Horizon value is $78.85.

Current Stock price = ($2.9568 + $78.85) / (1 + 6.24%)

= $77.00.

Current Stock price is $77.00.

b.

Dividend Yield = $2.9568 / $77

                         = 3.84%.

Dividend Yield is 3.84%.

Option (B) is correct answer.

b.

Number of stock issue = 150,000

diluted stock price = [(600,000 × $77) + (75,000 × $65.45)] / (1,200,000 + 150,000)

= ($92,400,000 + $9,817,500) / 1,350,000

= $102,217,500 / 1,350,000

= $75.72.

Diluted stock price is $75.72.

Judy\'s investment in Portman be diluted = $77.00 - $75.72

= $1.28

Judy\'s investment in Portman be diluted is equal to $1.28.

Total loss = $1.28 × 18,000

                 = $23,100.

Total Loss is $23,100.

Option (D) is correct answer.