Attempts: Do No Harm: 14 8. Nonconstant growth stock Aa Aa As companies evolve,

Question

Attempts: Do No Harm: 14 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 $1.92 per share. The company expects the coming year to be very profitable, and its dividend is expected to grow by 20.00% over the next year. After the next year, though, Portman's dividend is expected to grow at a constant rate of 4.00% per year. The risk-free rate (rr) is 5.00%, the market risk premium (RPM) is 6.00%, and Portman's beta is 1.30. Term Value Dividends one year from now (D1) Horizon value (P) 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? 8.46% 8.80% 7.04% 9.54% ql FJ FS F7 FB

Explanation / Answer

Answer:

Dividend One year from now (D1) = D0 + (D0 * g)
Current Dividend (D0) = $1.92
Growth Rate (g) = 20%
Dividend One year from now (D1) = 1.92 + (1.92 * 0.20)
Dividend One year from now (D1) = 1.92 + 0.384
Dividend One year from now (D1) = $2.304 or $2.30

Expected Rate of Return = Risk Free Rate + Beta * Market Risk Premium
Expected Rate of Return = 0.05 + (1.30 * 0.06)
Expected Rate of Return = 0.05 + 0.078
Expected Rate of Return = 0.128 or 12.8%

D2 = D1 * (D1 + g)
D2 = $2.304 + ($2.304 * 0.04)
D2 = $2.304 + $0.09216
D2 = $2.39616 OR $2.40

P1 = D2 / (r – g)
P1 = 2.40 / (0.128 – 0.04)
P1 = 2.40/ 0.088
P1 = $27.27

P0 = D1/(1+r) + P1/(1+r)
P0 = [2.304 / (1 + 0.128)] + [27.27 / (1 + 0.128)]
P0 = $2.0426 + $24.1756
P0 = $26.2182 or $26.22

Therefore, Intrinsic Value of Portman’s Stock is $26.22

Dividend Yield = D1 / P0
Dividend Yield = 2.304 / 26.22
Dividend Yield = 8.79%

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