Question regarding valuation/stocks that don’t pay dividends

Hi @b350, the image is really tiny, quite hard to see. Can you attach as a file on imgur?

@b350, @pranav – apologies it took a while to revert on this (PS @pranav i think your solution may have a mistake in that your solution is for a different question, see below). Here are my thoughts:

I’ll dive straight into the answer calculations (without the usual upfront notations):

1) For Horizon Value, I presume they meant Terminal Value (TV).

So TV = (D5*1.0402) / (0.134-0.0402) = (4*1.208^2 * 1.0402) / (0.0938) = $64.73  
(PS – @Pranav, this is your mistake here, this is an undiscounted terminal value and NOT current intrinsic value)

2) Current Intrinsic Value

This is just present value of the dividend cash flow and terminal value.

V0 = 4/(1.134^3) + (4*1.208)/(1.134^4) + (4*1.208^2)/(1.134^5) + 64.73/ (1.134^5) = $43.29

3) Total Return % = Div Yield + Capital Gains Yield

Total return is given at 14.40%, so we need to find expected Div yield at year 2 (DY3), and capital gains yield is then TR – DY3.

DY3 = dividend / price of shares are year 2 = 4 / V2

Using the same method of derivation as the previous 2 questions above by discounting the cashflow to year 2 (instead of year 0 for question 2), V2 = 4/(1.134) + (4*1.208)/(1.134^2) + (4*1.208^2)/(1.134^3) + 64.73/ (1.134^3) = $55.6756

(PS – you can also approximate this as V0 (i.e. answer from Question 2) *1.134^2)

So DY3 = 4/55.6756 = 7.18%

Are these correct answer wise @B350‌ ? 

@Sophie‌ 
horizon value – it says that horizon value is the value when constant growth begins, so shouldn’t it be in year 5? it would be the value before the dividend obtained from constant growth is paid, right? your calculation includes valuation from the constant growth…i think that should not be included…

current intrinsic value – i read the question wrong, i assumed current date as at end of year 6…it was at year 0…so i agree with your solution for that…
thanks for div. yield and capital gains yield calculations…

FYI @B350‌ , you can attach images like this using the attachment function, that way more people in the community can see it upfront and respond 🙂 

What particular areas of this question that you don’t understand? It’ll be helpful to show your thought process here so I can explain/help 🙂

@B350‌ 
hope i got this right, haven’t brushed up on these concepts since the exam…
D1=0
D2=0
D3=4
D4=4(1.208)=4.832
D5=4.832(1.208)=5.837
k=13.4%=0.134
g=4.02%=0.0402

Horizon value at horizon date, when constant growth begins, that is in year 5, hence we need V5. (use the multistage dividend growth model here)
V5=D3/(1+k)    +   D4/(1+k)(1+k)    +    P4/(1+k)(1+k)

solving for P4,
P4=D5/(k-g) = 5.837/(0.134-0.0402) = 62.228

substituting P4 in V5 equation,
V5=4/1.134   +  4.832/(1.134)(1.134)    +   62.228/(1.134)(1.134) = 55.673

Current intrinsic value should take into account the constant dividends since year 5(use Gordon growth model)
V=D5(1+g)/(k-g) = 5.837*1.0402/(0.134-0.0402) = 64.73

i am sorry but i don’t know how to get the DY3 and CGY3…if someone answers that, please tag me too…do that if my solution above is wrong too… :sweat_smile: