B20. (Constant growth model) Medtrans is a profitable firm that is notpaying a d
ID: 2662097 • Letter: B
Question
B20.
(Constant growth model) Medtrans is a profitable firm that is notpaying a dividend on its common stock. James Weber, an analyst forA. G. Edwards, believes that Medtrans will begin paying a $1.00 pershare dividend in two years and that the dividend will increase 6%annually thereafter. Bret Kimes, one of James’ colleagues atthe same firm, is less optimistic. Bret thinks that Medtrans willbegin paying a dividend in four years, that the dividend will be$1.00, and that it will grow at 4% annually. James and Bret agreethat the required return for Medtrans is 13%.
B20.
(Constant growth model) Medtrans is a profitable firm that is notpaying a dividend on its common stock. James Weber, an analyst forA. G. Edwards, believes that Medtrans will begin paying a $1.00 pershare dividend in two years and that the dividend will increase 6%annually thereafter. Bret Kimes, one of James’ colleagues atthe same firm, is less optimistic. Bret thinks that Medtrans willbegin paying a dividend in four years, that the dividend will be$1.00, and that it will grow at 4% annually. James and Bret agreethat the required return for Medtrans is 13%.
- What value would James estimate for this firm?
- What value would Bret assign to the Medtrans stock?
Explanation / Answer
James expected dividend(D2) = $1 Dividend growth rate (g) = 6% Required Return ( R) =13% (a)Calculating Stock Value of James(P0): Today's Stock Value(P0) = [D1/(1+R) +D2/(1+R)2+ D3/(1+R)3+ P3/(1+R)3] Dividend paid in 1st year(D1) = $1 Dividend paid in 2nd year(D2) = $1 Dividend paid in 3rdyear (D3) = $1 (1+0.06) = $1.06 Dividend paid in 4thyear (D4) = $1.06 * (1.06) =$1.1236 Calculating Stock Valuein 3rd year (P3) = D4 / (R -g) Stock Value in 3rd year(P3) = $1.1236 / (0.13 - 0.06) Stock Value in 3rd year(P3) = $16.05 Today's Stock Value(P0) = [D1/(1+R) +D2/(1+R)2+ D3/(1+R)3+ P3/(1+R)3] Today's Stock Value(P0) = [$1 / (1+0.13) + $1 /(1+0.13)2 + $1.06 / (1+0.13)3 + $16.05 /(1+0.13)3] Today's Stock Value(P0) = [$0.8849 + $0.783 + $0.735+$11.12] StockValue of James (P0) = $13.53 (b)Calculating Stock Value of BretEstimation (P0): Today's Stock Value(P0) = [D1/(1+R) +D2/(1+R)2+ D3/(1+R)3+ P3/(1+R)3] Dividend paid in 1st year(D1) = $1 Dividend paid in 2nd year(D2) = $1 Dividend paid in 3rdyear (D3) = $1 (1+0.04) = $1.04 Dividend paid in 4thyear (D4) = $1.04 * (1.04) =$1.0816 Calculating Stock Valuein 3rd year (P3) = D4 / (R -g) Stock Value in 3rd year(P3) = $1.0816 / (0.13 - 0.04) Stock Value in 3rd year(P3) = $12.02 Today's Stock Value(P0) = [D1/(1+R) +D2/(1+R)2+ D3/(1+R)3+ P3/(1+R)3] Today's Stock Value(P0) = [$1 / (1+0.13) + $1 /(1+0.13)2 + $1.04 / (1+0.13)3 + $12.02 /(1+0.13)3] Today's Stock Value(P0) = [$0.8849 + $0.783 + $0.721+$8.33] StockValue of James (P0) = $10.72 James expected dividend(D2) = $1 Dividend growth rate (g) = 6% Required Return ( R) =13% (a)Calculating Stock Value of James(P0): Today's Stock Value(P0) = [D1/(1+R) +D2/(1+R)2+ D3/(1+R)3+ P3/(1+R)3] Dividend paid in 1st year(D1) = $1 Dividend paid in 2nd year(D2) = $1 Dividend paid in 3rdyear (D3) = $1 (1+0.06) = $1.06 Dividend paid in 4thyear (D4) = $1.06 * (1.06) =$1.1236 Calculating Stock Valuein 3rd year (P3) = D4 / (R -g) Stock Value in 3rd year(P3) = $1.1236 / (0.13 - 0.06) Stock Value in 3rd year(P3) = $16.05 Today's Stock Value(P0) = [D1/(1+R) +D2/(1+R)2+ D3/(1+R)3+ P3/(1+R)3] Today's Stock Value(P0) = [$1 / (1+0.13) + $1 /(1+0.13)2 + $1.06 / (1+0.13)3 + $16.05 /(1+0.13)3] Today's Stock Value(P0) = [$0.8849 + $0.783 + $0.735+$11.12] StockValue of James (P0) = $13.53 (b)Calculating Stock Value of BretEstimation (P0): Today's Stock Value(P0) = [D1/(1+R) +D2/(1+R)2+ D3/(1+R)3+ P3/(1+R)3] Dividend paid in 1st year(D1) = $1 Dividend paid in 2nd year(D2) = $1 Dividend paid in 3rdyear (D3) = $1 (1+0.04) = $1.04 Dividend paid in 4thyear (D4) = $1.04 * (1.04) =$1.0816 Calculating Stock Valuein 3rd year (P3) = D4 / (R -g) Stock Value in 3rd year(P3) = $1.0816 / (0.13 - 0.04) Stock Value in 3rd year(P3) = $12.02 Today's Stock Value(P0) = [D1/(1+R) +D2/(1+R)2+ D3/(1+R)3+ P3/(1+R)3] Today's Stock Value(P0) = [$1 / (1+0.13) + $1 /(1+0.13)2 + $1.04 / (1+0.13)3 + $12.02 /(1+0.13)3] Today's Stock Value(P0) = [$0.8849 + $0.783 + $0.721+$8.33] StockValue of James (P0) = $10.72Related Questions
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