Question

9. Stocks that don't pay dividends yet 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 $2.25000 dividend at that time (D = $2.25000) and believes that the dividend will grow by 11.70000% for the following two years (D, and Ds). However, after the fifth year, she expects Goodwin's dividend to grow at a constant rate of 3.60000% per year. Goodwin's required return is 12.00000%. 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 If investors expect a total return of 13.00%, what will be Goodwin's expected dividend and capital gains yield in two years-that is, the year before the firm begins paying dividends? Again, remember to carry out the dividend values to four decimal places. (Hint: You are at year 2, and the first dividend is expected to be paid at the end of the year. Find DY, and CGY.) Expected dividend yield (DY) Expected capital gains yield (CGY3) Goodwin has been very successful, but it hasn't paid a dividend yet. It circulates a report to its key investors containing the following statement: Goodwin's investment opportunities are poor.

Answer 1

Solution:

We know that $D_{3}$ = $2.25,

D4 = D3(1+9)=2.25 (1.117) = 2.513

D5 = D4(1+9)=2.513 (1.117) = 2.807

D&= D:(1+9n) =2.807 (1.036) = 2.908

The horizon value is calculated using the formula

D6 Horizonvalue = 11

2.908 Horizonvalue = 7 (0.12 -0.036)

Horizon value = $34.62

The current intrinsic value is calculated using the equation

D1 D2 D3 D4 D5 + Ps = (1+1)*(1 + 5)2 + (1+k)3+ (1+k:)4*(1 + k)5

2.25 2.5132.807 +34.62 VTVT (1.1213 + (1.12)4 T (1.12)5

$24.44

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After 2 years dividend yield = 12% - 3.6% = 8.4%

After 2 years capital gain yield = 3.6%

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No, this statement does not explain why the firm has not paid a dividend because Goodwin has to record a profit yet.