W998AMMT.6
6. The Washington Redskins recently sold for a record $800 million. The NFL and the Redskins will last long enough that they can effectively be assumed to last forever. Profits from the Redskins are expected to be $100 million next year and then grow at the rate of 4% per year. If the appropriate discount rate for NFL franchises is 11%, did the buyer get a good price or not? (5)
We covered growing perpetuities in Lecture 4. The example on slide 51 and the "Widget" problem from slide 62 are similar to this problem. Since the Redskins can be assumed to last forever, their profits can be treated as a perpetuity. In this case, the profits will grow over time, so we need to use the formula for a growing perpetuity. Thus the PV of all of the Redskins’ future profits is:
$100 / (.11 - .04) = $1.428 billion, so under this scenario, it was a good price.