B20. (Constant growth model) Medtrans is a profitable firm that is not paying a

Question

B20. (Constant growth model) Medtrans is a profitable firm that is not paying a dividend on its common stock. James Weber, an analyst for A. G. Edwards, believes that Medtrans will begin paying a $1.00 per share dividend in two years and that the dividend will increase 6% annually thereafter. Bret Kimes, one of James’ colleagues at the same firm, is less optimistic. Bret thinks that Medtrans will begin paying a dividend in four years, that the dividend will be $1.00, and that it will grow at 4% annually. James and Bret agree that the required return for Medtrans is 13%.
1. What value would James estimate for this firm?
2. What value would Bret assign to the Medtrans stock?

Explanation / Answer

a. P1 = D2 / (r - g) = $1.00 / (0.13 - 0.06) = $14.29 P0 = $14.29 / (1 + 0.13)1 = $12.64 b. P3 = D4 / (r - g) = $1.00 / (0.13 - 0.04) = $11.11 P0 = $11.11 / (1 + 0.13)3 = $7.70

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