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 $4.5000 dividend at that time (D3 = $4.5000) and believes that the dividend will grow by 23.40% 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 4.14% per year. Goodwin's required return is 13.80%. 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 Assuming that the markets are in equilibrium, Goodwin's current expected dividend yield is Goodwin's capital gains yield is and 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 has yet to record a profit (positive net income) Is this statement a possible explanation for why the firm hasn't paid a dividend yet? Yes O No

Explanation / Answer

Soln: Here, please note all values are in dollar:

Dividend to pay in 3rd year from now D3 = 4.5 in 4th and 5th year dividend will increase by 23.40%

Hence, D4 = 4.5*(1+0.234) = 5.553 & D5 = 6.8524

Horizon value , we can call it terminal value also is the future values of an asset at a point where the growth of return is constant. Like here from 6th year the growth is constant of dividends i.e. 4.14%

Now, we can calculate the horizon value by using the perpetuity growth model i.e. :

HV = FCF/(r-g)

where, r = required rate of return, g = growth rate and FCF = constant cash flows from the year 5th when it grows at constant rate.

HV = 6.8524*100/(13.8-4.14) = 70.9358 at the start of 6th year.

Current intrinsic value, V = discounted value of Future Cash flows at required rate of return + discounted value of terminal value

V = 4.5/(1.138)3 + 5.553/(1.138)4 + 6.8524/(1.138)5 + 70.9358/(1.138)5

V = 47.1215 = current intrinsic value.

At present no dividend will be paid , so dividend yield is 0 and the capital gain yield is defined as the appreciation in share price over the period, as market is in equilibirium . So required rate of return is the current capital yield = 13.80%.

The statement is correct as the dividend can only be distributed from the profit earned over the last year.

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