Question

The Sports Club plans to pay an annual dividend of $1.20 per share next year, $1.12 per share a year for the following two years, and then in year 4 expects its dividend to increase at a constant rate of 8.8% per year. How much is one share of this stock worth to you today if you require a rate of return of 18.7 percent of this risky investment?

Answer 1

The value of the stock is computed as shown below:

= Dividend in year 1 / (1 + required rate of return)¹ + Dividend in year 2 / (1 + required rate of return)² + Dividend in year 3 / (1 + required rate of return)³ + 1 / (1 + required rate of return)³ [ ( Dividend in year 3 (1 + growth rate) / ( required rate of return - growth rate) ]

= $ 1.20 / 1.187 + $ 1.12 / 1.187² + $ 1.12 / 1.187³ + 1 / 1.187³ x [ ($ 1.12 x 1.088) / (0.187 - 0.088) ]

= $ 1.20 / 1.187 + $ 1.12 / 1.187² + $ 1.12 / 1.187³ + $ 12.30868687 / 1.187³

= $ 1.20 / 1.187 + $ 1.12 / 1.187² + $ 13.42868687 / 1.187³

= $ 9.84

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