Hart Enterprises recently paid a dividend, D0 of $1.25. It expects to have non-constant growth of...

Question:

Hart Enterprises recently paid a dividend, D0 of $1.25. It expects to have non-constant growth of 20% for 2 years followed by a constant rate of 5% thereafter. The firm's required return is 10%. What is the firm's horizon, or continuing value?

Continuing Value:

In the discounted dividend model, the continuing value of a stock is the value of the stock at a point after which the dividends will grow at a constant rate. This value, together with the estimated stream of dividends, determines the price of the stock today.

Answer and Explanation:

The continuing value of a stock is the price of the stock at a point after which the dividends will grow at a constant rate indefinitely. In this question, the stock's dividend will be growing at a constant rate of 5% after 2 years. Therefore, the continuing value is the price of the stock at the end of year 2. We can use the dividend growth model to compute the continuing value as follows:

  • price per share = last dividend * (1 + growth rate) / (required return - growth rate)

Applying the formula, the continuing value is:

  • {eq}1.25*(1 + 20\%)^2*(1 + 5\%) / (10\% - 5\%) = 37.8 {/eq}

Learn more about this topic:

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The Dividend Growth Model

from Finance 101: Principles of Finance

Chapter 14 / Lesson 3
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