Hello ! Was hoping somebody smarter than me can assist. This was in my textbook (image link of page)
Unfortunately, the textbook really doesn’t explain how to work this. Thank You for whatever assistance you can provide.
hope i got this right, haven’t brushed up on these concepts since the exam…
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:
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%
And therefore Capital Gains Yield = 14.4% – 7.18% = 7.22%
Are these correct answer wise @B350 ?
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…
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