8. Nonconstant growth stock Aa Aa As companies evolve, certain factors can drive

Question

8. 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 $1.68 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 (RF) 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) 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? 0 3.98% ? 3.75% 3.84% ? 3.07%

Explanation / Answer

D0 = $1.68

Growth rate is 12.00% over the next year and constant growth rate (g) of 2.40% thereafter

Required Return = Risk-free rate + beta * Market risk premium
Required Return = 3.00% + 0.90 * 3.60%
Required Return = 6.24%

Dividends one year from now, D1 = $1.68 * 1.12
Dividends one year from now, D1 = $1.88

D2 = $1.88 * 1.024
D2 = $1.93

Horizon value, P1 = D2 / (Required Return - Growth Rate)
Horizon value, P1 = $1.93 / (0.0624 - 0.024)
Horizon value, P1 = $50.26

Intrinsic Value = $1.88/1.0624 + $50.26/1.0624
Intrinsic Value = $49.08

Dividend Yield = Dividends one year from now / Intrinsic Value
Dividend Yield = $1.88 / $49.08
Dividend Yield = 3.84%

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