Problem 6 Medical Corporation of America (MCA) has a current stock price of $36, and its last dividend (D) was $2.40. In view of MCA’s strong financial position, its required rate of return is 12 percent. If MCA’s dividends are expected to grow at a constant rate in the future, what is the firm’s expected stock price in five years?

Stock price = $36
Required rate of return = 12%
Dividend just paid = $2.40
From Gordon growth model,
Price = Dividend next year / (Required return – growth)
36 = 2.40 * (1+g)/ (0.12 – g)
Solving for g, we get growth rate = 5%
Considering growth rate in earnings to be 5 % per year, Dividend payment in five years will be
Dividend just paid * (1.05)^5 = 2.40 * 1.27 = $3.06
Stock price in five years = Dividend in 6th year/ Required return – Growth)
= 3.06 * 1.05 / (0.12-0.05) = 3.21/0.07 = $45.85
 
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