Valuing Stock Using the Dividend Growth Model
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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 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%.
A. What value would James estimate for this firm?
B. What value would Bret assign to the Medtrans stock?
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Solution Summary
This solution gives the formula for the Dividend Growth Model and applies it to deferred dividends.
Solution Preview
The Dividend Growth Model states that the price of a company's stock is equal to its dividend one year from today divided by the excess of its required rate of return over its annual growth rate. (In other words, P=D/(R-g).) ...
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