(Constant growth model) Medtrans is a profitable firm thatis not paying a divide
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Question
(Constant growth model) Medtrans is a profitable firm thatis not paying a dividend on its common stock. James Weber, ananalyst for A.G. Edwards, believes that Medtrans will begin payinga $1.00 per share dividend in two years and that the dividend willincrease 6% annually thereafter. Bret Kimes, one ofJames’colleagues at the same firm, is lessoptimistic. Bret thinks that Medtrans will begin paying adividend in four years, that the dividend will be $1.00, and thatit will grow at 4% annually. James and Bret agree that therequired return for Medtrans is 13%.
a. What value would Jamesestimate for this firm?
b. What value would Bret assign tothe Medtrans stock?
Explanation / Answer
(a)Calculating Value of the Medtrans Stock estimated byJames: Dividend Paid in 2 years(D2) = $1 Dividend growth rate(g) = 6% Required Rate of Return (R) = 13% Medtrans Stock Value(P2) = D3 / (R - g) Medtrans Stock Value(P2) = D2 (1+g) / (0.13 - 0.06) Medtrans Stock Value(P2) = $1 (1.06) / 0.07 Medtrans Stock Value(P2) = $1.06 / 0.07 Medtrans StockValue = $15.14 (b) CalculatingMedtrans Stock assigned by Bret: Medtrans Stock Value(P4) = D5 / (R - g) Medtrans Stock Value(P4) = D5 (1+g) / (0.13 -0.04) Medtrans Stock Value(P4) = $1 (1.04) / 0.09 Medtrans Stock Value(P4) = $1.04 / 0.09 Medtrans StockValue = $11.55 (a)Calculating Value of the Medtrans Stock estimated byJames: Dividend Paid in 2 years(D2) = $1 Dividend growth rate(g) = 6% Required Rate of Return (R) = 13% Medtrans Stock Value(P2) = D3 / (R - g) Medtrans Stock Value(P2) = D2 (1+g) / (0.13 - 0.06) Medtrans Stock Value(P2) = $1 (1.06) / 0.07 Medtrans Stock Value(P2) = $1.06 / 0.07 Medtrans StockValue = $15.14 (b) CalculatingMedtrans Stock assigned by Bret: Medtrans Stock Value(P4) = D5 / (R - g) Medtrans Stock Value(P4) = D5 (1+g) / (0.13 -0.04) Medtrans Stock Value(P4) = $1 (1.04) / 0.09 Medtrans Stock Value(P4) = $1.04 / 0.09 Medtrans StockValue = $11.55Related Questions
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