Ridgemont Can Company Latest Dividend Of 150 Was Paid Yester

Ridgemont Can Company Latest Dividend Of 150 Was Paid Yesterday And

Ridgemont Can Company paid a recent dividend of $1.50 and has historically maintained a 7 percent annual growth rate. You are considering purchasing the stock today, anticipating an increase in the growth rate to 8 percent for the next three years, after which the stock is expected to reach $50 per share. The assignment involves calculating how much you should be willing to pay for the stock under different growth scenarios, as well as determining the stock price at the end of year 3 and considering a decline in growth rate after three years.

Paper For Above instruction

The valuation of stocks based on dividend growth models is a fundamental approach in finance that helps investors determine the fair price of a stock given expected dividends and growth rates. In this case, we are analyzing Ridgemont Can Company’s stock with different growth scenarios and calculating its intrinsic value based on these assumptions.

Dividend Discount Model (DDM) and Growth Assumptions

The core valuation method to be used is the Gordon Growth Model or the Dividend Discount Model for a perpetually growing dividend:

  • V₀ = D₁ / (r - g)

where V₀ is the current stock price, D₁ is the dividend expected next year, r is the required rate of return, and g is the growth rate.

Step 1: Initial Data and Assumptions

  • Dividend paid yesterday (D₀) = $1.50
  • Historical constant growth rate, g₀ = 7%
  • Expected growth for the next 3 years = 8% (g₁ = g₂ = g₃ = 8%)
  • Price after 3 years = $50
  • Required rate of return, r = 14%

Step 2: Calculate the Dividend for the Next Year (D₁)

Since the dividend just paid is D₀ = $1.50, and the growth is expected to be 8% for the next three years:

D₁ = D₀ × (1 + g) = $1.50 × (1 + 0.08) = $1.50 × 1.08 = $1.62

Step 3: Valuation with Growth Increasing to 8% for Three Years

We need to calculate the stock price today, considering the high growth period (8%) followed by the target price ($50). The valuation will be based on the present value of dividends during the high-growth period and the terminal value at the end of year 3.

Dividend at Year 2 and Year 3:

  • D₂ = D₁ × (1 + g) = $1.62 × 1.08 = $1.75
  • D₃ = D₂ × 1.08 = $1.75 × 1.08 = $1.89

Calculating the Price at the End of Year 3 (P₃):

At the end of year 3, the stock is expected to reach $50, so the price at the end of year 3 (P₃) is given as $50.

Discounting to Present Value:

Using the required rate of return, r = 14%, we discount the dividends and the terminal value back to today:

  • PV of dividends during years 1-3:

PV_Div_1 = D₁ / (1 + r) = $1.62 / 1.14 ≈ $1.42

PV_Div_2 = D₂ / (1 + r)² = $1.75 / (1.14)² ≈ $1.35

PV_Div_3 = D₃ / (1 + r)³ = $1.89 / (1.14)³ ≈ $1.20

  • Present value of the stock price at year 3 (P₃):

PV_P₃ = P₃ / (1 + r)³ = $50 / (1.14)³ ≈ $34.75

Now, sum all present values to find the current fair price:

P₀ = PV_Div_1 + PV_Div_2 + PV_Div_3 + PV_P₃ ≈ $1.42 + $1.35 + $1.20 + $34.75 ≈ $38.72

Step 4: Valuation with Indefinite 8% Growth

If the growth rate of 8% is maintained indefinitely, the valuation simplifies to the Gordon Growth Model:

V₀ = D₁ / (r - g) = $1.62 / (0.14 - 0.08) = $1.62 / 0.06 = $27.00

Step 5: Price at the End of Year 3

Using the same perpetual growth model for year 3 onwards:

P at year 3 = D₄ / (r - g) = D₃ × (1 + g) / (r - g) = $1.89 × 1.08 / 0.06 ≈ $34.17

Step 6: Price with Declining Growth after 3 Years

If growth declines to 7% after 3 years and is maintained indefinitely, the terminal value at year 3 becomes:

P₃ = D₄ / (r - g_new) = D₃ × (1 + g_new) / (r - g_new) = $1.89 × 1.07 / (0.14 - 0.07) ≈ $1.89 × 1.07 / 0.07 ≈ $28.91

Discounting this back to present:

PV_P₃ = $28.91 / (1.14)³ ≈ $28.91 / 1.481 ≈ $19.52

The present value of the stock considering the initial growth and the declined perpetuity becomes:

P₀ ≈ $1.42 + $1.35 + $1.20 + $19.52 ≈ $43.49

Conclusion

Based on the assumptions, the fair value of Ridgemont Can Company stock varies significantly depending on the growth scenario. If the company maintains a perpetual 8% growth rate, the stock should be valued at approximately $27. However, considering the high-growth period (8%) for three years and then a decline to 7%, the stock’s value is estimated at about $43.49. When the stock is expected to reach $50 at the end of three years, we derive a present value close to $38.72, which investors might consider a reasonable purchase price if their required return is 14%.

References

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