Goodwin Technologies, a relatively young company, has been wildly successful but

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 $2.7500 dividend at that time (D3 = $2.7500) and believes that the dividend will grow by 14.30% for the following two years (D_4 and D_5). However, after the fifth year, she expects Goodwin's dividend to grow at a constant rate of 3.72% per year. Goodwin's required return is 12.40%. 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, carry the dividend values to four decimal places. If investors expect a total return of 13.40%, 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. (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. Is this statement a possible explanation for why the firm hasn't paid a dividend yet?

Explanation / Answer

1) If Goodwin's required return is 12.4%, what is Goodwin's horizon value at the horizon date-- when constant growth begins? 2) What is Goodwin's current intrinsic value? Horizon Value Year Dividend(n) x (1+14.30%) 3 $2.7500 4 $3.1433 5 $3.5927 a) Horizon value, use Gordon growth model: Price (at t=5) ;P5 = D5 x (1+g)/ (r - g) Horizon Value = (D5 x (1+3.72%))/(12.4%-3.72%) $42.9307 b) Intrinsic Value Year Cash Flows PV @ 12.40% Present Value 3 $2.7500 0.704208 $1.9366 4 $3.1433 0.626520 $1.9693 5 $46.5234 0.557402 $25.9322 $29.8381 Year 5 cash flow = D5 + Horizon Value = $3.59 + $42.93 $46.5234 Intrinsic Value $29.84 c) If investors expect a total return of 13.40%.What are Goodwin's expected dividend and capital gains yields in two years--that is, the year before the firm begins paying dividends? (Hint: You are at Year 2, and the first dividend is expected to be paid at the end of the year. Find DY2 and CGY2.) D3 above is "now" (at t=2) D1 Dividend yield = D1 / P0 P2 = D1 x (1+g)/r-g = $2.75 x (1+3.72%)/(13.40%-3.72%) $29.46591 Dividend yield (t=2) = $2.75/$29.465 9.33282% Rate (given) 13.40% (d) Capital gain Yield = Rate of Return - Dividend Yield 4.07%

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