7. Nonconstant growth stock As companies evolve, certain factors can drive sudde

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7. Nonconstant growth stock

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 $1.20 per share. The company expects the coming year to be very profitable, and its annual dividend is expected to grow by 16.00% over the next year. After the next year, however, Portman’s dividend is expected to grow at a constant rate of 3.20% per year.

Given this data—and assuming the market is in equilibrium—complete the following table:

Term

Value

$1.66 per share

$1.39 per share

$1.24 per share

$1.43 per share

$13.37 per share

$44.69 per share

$13.75 per share

$15.21 per share

$15.98 per share

$13.32 per share

$12.10 per share

$15.95 per share

Points:

Close Explanation

Explanation:

Given this information, the expected dividend yield for Portman’s stock today is selector 1

10.11%

10.74%

11.49%

10.44

Portman has 200,000 shares outstanding, and Judy Davis, an investor, holds 3,000 shares at the current price as just computed. Suppose Portman is considering issuing 25,000 new shares at a price of $11.32 per share. If all of the new shares are sold to outside investors, then Judy’s investment in Portman will be diluted by selector 1

$0.46

$0.27

$0.22

$0.19

per share, and she will experience a total selector 2

loss

profit

of selector 3

$429.00

$660.00

$792.00

$495.00

.

Term

Value

Dividends one year from now ( ) selector 1

$1.66 per share

$1.39 per share

$1.24 per share

$1.43 per share

Horizon value (Stock’s value at end of the nonconstant dividend growth period — ) selector 2

$13.37 per share

$44.69 per share

$13.75 per share

$15.21 per share

Intrinsic value (Theoretical market price) selector 3

$15.98 per share

$13.32 per share

$12.10 per share

$15.95 per share

Explanation / Answer

1)D1 = 1.2(1+.16)=1.392   [rounded to 1.39]

Correct option is "B"

2) Return on stock (Rs) =Rf+[Beta*RM]

                           = 4 + [2*4.8]

                           = 4 + 9.6 = 13.6%

Horizon value = 1.39(1+ .032) / (.136- .032)

                     = 1.39 * 1.032 / .104

                    = $ 13.79    [approx to 13.75]

correct option is "C"

3)Intrinsic value =PVF@13.6%,1 *CF

                    = .88028 * 15.14                         [1.39+13.75]

                 = $ 13.32

COrrect option is "B"

4)Dividend yield = 1.39 / 13.32 =10.44%

correct option is D""

5)correct option is "C" = .22

[Price today = 13.32

Price if new shares issued = (200000*13.32)+(25000*11.32)/ (200000+25000)]

                                      = [2664000+ 283000]/225000

                                       = 13.10

Dilution = 13.32-13.10 = .22

6) Total loss= .22 * 3000 = $ 660

correct option is "B"

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