Question

Aerelon Airways, a commercial airline, suffers a major crash. As a result, passengers are
considered to be less likely to choose Aerelon as their carrier, and it is expected free cash flows
will fall by $15million per year for five years. If Aerelon has 55 million shares outstanding, an
equity cost of capital of 10%, and no debt, by how much would Aerelonʹs shares be expected to
fall in price as a result of this accident?
A) $0.93
B) $1.03
C) $1.14
D) $1.34

Answer 1

Answer:

Option B $1.03

Explanation:

First lets calculate present value = cash flow(PVAF, life, rate) where PVAF = present value annuity factor

= 15(PVAF, 10, 5 years)

from the annuity table

Present value = 15 * 3,790 = $56.8618 million

The decrease in Present value will be  $56.8618 million

Decrease in price = present value/number of share = 56.8618/66 = 1.033851 approx $1.03