9. Stocks that don\'t pay dividends yet Goodwin Technologies, a relatively young

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 $3.5000 dividend at that time (D3 = $3.5000) and believes that the dividend will grow by 18.20% for the following two years (D4 and Ds). However, after the fifth year, she expects Goodwin's dividend to grow at a constant rate of 3.90% per year. Goodwin's required return is 13.00%. 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. Term Value Horizon value Current Intrinsic value If investors expect a total return of 14.00%, 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 DY3 and CGY3.)

Explanation / Answer

D3= $3.50

D4 = 3.50*1.1820= $4.1370

D5= 4.1370*1.1820= $4.8899

D6= 4.8899*1.0390= $5.0806

Horizon value= V5= D6/(Re-g) = 5.0806/(0.13-0.039)= $55.8308

Intrinsic value:

using BA II plus calculator

go to cash flow mode

C0=0, C1=0, C2=0,C3= 3.50, C4= 4.1370, C5= 55.8308+4.8899 i.e., 60.7207

I= 13, NPV= $37.92

Intrinsic value= $ 37.92

Assuming substantial growth rate be 3.90% , it means out of 14% return 3.90% will be acheived by the way of capital gains i.e., growth in price . Hence Investor will require only 10.10% from dividend excluding growth.

Expected capita gains yeild= 3.90%

Expected dividend yeild= 10.10%

Since the company has been successful and has not been paying dividend ,it does not mean that company is having poor investment oppoutunities.Rather ininitial years either company was not generating sufficient profits to pay dividend or it have a better investment oppourtunities which maximises the wealth of shareholders reflected by share price. The company has been succesful in past years, it means it was having better investment oppourtunities

Hence the statement is not explanation of why the firm havent paid dividend.

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