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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%.

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

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.