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Stock Valuation Using the 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 Medtans is 13%.

Questions:
a. What value would James estimate for this firm?
b. What value would Bret assign to the Medtrans stock?

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Solution Preview

Please see the attached file.

a. What value would James estimate for this firm?

Year Dividend growth rate Dividend
2 D2 $1.0000
3 D3 6.0% $1.0600 =( 1 + 6.% ) x $1.

Find the value of the stock at end of year 2
Using the Dividend Discount (Constant Growth) Model
P2= D3/ (r-g)

Dividend for the year 3 = D3= $1.0600
required ...

Solution Summary

This solution is comprised of a step by step response which illustrates how to estimate the value for both the firm and the Medtrans stock. An Excel file is also attached which formats this solution in a more structured manner.

$2.19