Car Parts Center recently announced that it will pay annual dividends at the end of the next two years of $1.20 and $1.35 per share, respectively. Then, in Year 5 it plans to pay a final dividend of $11.75 a share before closing its doors permanently. At a required return of 17 percent, what should this stock sell for today

The stock should sell for = $7.37

Explanation:

The value of a share is the sum of the present values of its expected future cash flows discounted at its shareholders' required rate of return.

In other words, the worth of a share is the amount that needs to be invested today at the required rate of return to equal the total sum of the future dividends expected from the share.

To calculate the value of a share, we calculate the present value of the future dividends using the required rate of return

Present Value = (1+r) ^ (-n) * Cash flow

Lets apply this to information provided for Car Parts Center:

Year 1 = (1+0.17) ^ (-1) * 1.20 = 1.03

Year 2 = (1+0.17) ^ (-2) * 1.35=0.99

Year 5 = (1+0.17) ^ (-5) * 11.75=5.36

Value of share = 1.03 + 0.99 + 5.36 = $7.37

The stock should sell for = $7.37