Constant growth model) Medtrans is a profitable firm that is not paying a divide

Question

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%.

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

Explanation / Answer

Calculating the Current value of the firm: a) According to the estimation of James, D1 = $1.00 D2 = $1.00 Growth rate = 6% Years = 2 Required return (R) = 13% P2 = D3 / (R-g)      = [$1.00 (1+0.06)] / (0.13 - 0.06)      = $15.143 According to Constant Dividend growth model, the formula for calculating the present value of the stock is P0 = D1 / (1+R)^1 + D2 / (1+R)^2 + P2 / (1+R)^2      = $1.00 / (1+0.13) + $1.00 / (1+0.13)^2 + $15.143 / (1+0.13)^2      = $0.885 + $0.783 + $11.86      = $13.53 Therefore,. the present value of the stock is $13.53 b) CAlculating the value of the stock according to Bret estimation: D1 = $1.00 D2 = $1.00 D3 = D2 * (1+g)      = $1.00 (1+0.04)      = $1.04 D4 = D3 * (1+g)       = $1.04 (1+0.04)       = $1.082 Growth rate = 4% Years = 4 Required return (R) = 13% P4 = D5 / (R-g)      = [$1.082 (1+0.04)] / (0.13 - 0.04)      = $12.5 According to Constant Dividend growth model, the formula for calculating the present value of the stock is P0 = D1 / (1+R)^1 + D2 / (1+R)^2 + D3 / (1+R)^3 + D4 / (1+R)^4 + P4 / (1+R)^4      = $1.00 / (1+0.13) + $1.00 / (1+0.13)^2 +$1.04 / (1+0.13)^3 + $1.082 / (1+0.13)^4 + $12.5 /(1+0.13)^4      = $0.885 + $0.783 + $0.72 + $0.664 + $7.67      = $10.72 Therefore,. the present value of the stock is $10.72 D1 = $1.00 D2 = $1.00 D3 = D2 * (1+g)      = $1.00 (1+0.04)      = $1.04 D4 = D3 * (1+g)       = $1.04 (1+0.04)       = $1.082 Growth rate = 4% Years = 4 Required return (R) = 13% P4 = D5 / (R-g)      = [$1.082 (1+0.04)] / (0.13 - 0.04)      = $12.5 According to Constant Dividend growth model, the formula for calculating the present value of the stock is P0 = D1 / (1+R)^1 + D2 / (1+R)^2 + D3 / (1+R)^3 + D4 / (1+R)^4 + P4 / (1+R)^4      = $1.00 / (1+0.13) + $1.00 / (1+0.13)^2 +$1.04 / (1+0.13)^3 + $1.082 / (1+0.13)^4 + $12.5 /(1+0.13)^4      = $0.885 + $0.783 + $0.72 + $0.664 + $7.67      = $10.72 Therefore,. the present value of the stock is $10.72

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