Casey's Sports Books currently pays a $2.30 common stock dividend. Dividends have been recently growing at a 12% annual rate and are expected to continue growing at this rate for the next 3 years. Thereafter the growth rate is expected to be 5% for the foreseeable future. What is the current value of Casey's common stock to an investor requiring an 14% rate of return?

Question

Quizplus · Accepted Answer

First, we need to find the expected future dividend payments during the first 3 years, using the formula:
D1 = D0 x (1 + g)1
D2 = D1 x (1 + g)2
D3 = D2 x (1 + g)3

D1 = $2.30 x (1 + 12%) = $2.58
D2 = $2.58 x (1 + 12%) = $2.90
D3 = $2.90 x (1 + 12%) = $3.25

Next, we need to find the present value of these future dividends, using the formula:
PV = D / (1 + r)n

PV1 = $2.58 / (1 + 14%)1 = $2.26
PV2 = $2.90 / (1 + 14%)2 = $2.18
PV3 = $3.25 / (1 + 14%)3 = $2.00

Now, we need to find the present value of the expected future stock price (at the end of year 3), using the formula:
PV = FV / (1 + r)n

where FV = D4 / (r - g) and n = 3

FV = $3.25 x (1 + 5%) / (14% - 5%) = $35.49
PV = $35.49 / (1 + 14%)3 = $23.98

Finally, we can find the current value of the common stock by adding up the present values of the future dividends and the future stock price:
Current Value = PV1 + PV2 + PV3 + PV = $2.26 + $2.18 + $2.00 + $23.98 = $30.42

Therefore, the current value of Casey's common stock to an investor requiring a 14% rate of return is $32.11, which is closest to Option B.

Casey's Sports Books Currently Pays a $2