Question

California Real Estate, Inc., expects to earn $85 million per year in perpetuity if it does not undertake any new projects. The firm has an opportunity that requires investing $18 million today and $7 million in one year. This new project will then generate annual profits of $11 million beginning at the end of year two and continuing in perpetuity. The firm has 20 million shares of common stock outstanding, and its required rate of return is 12%. Ignore taxes, depreciation, and other complications.
A. What is the price of a share of stock if the firm does not undertake the new investment?
B. What is the value of the investment?
C. What is the per-share stock price if the firm undertakes the investment?

Answer 1

Answer:

Kindly check explanation

Explanation:

Given the following :

Expected earning = $85,000,000 per year

Required rate of return on stock (r) = 12% = 0.12

Number of common stock shares outstanding = 20 million

A.) price of a share of stock if the form does not undertake new investment:

Cash value = $85,000,000 / 0.12

= $708333333.33

Price of share :

708333333.33 / 20,000,000

= $35.42

B.) calculate the NPV of growth opportunities :

Investment opportunity today (Co) = $18 milliom

Investment opportunity after a year (C1) = $7 million

Annual profit at the end of year 2 = $11 million

The net present value of growth opportunities :

Co + C1/(1+r) + (C2 / r) / (1 + r)

-18,000,000 - 7,000,000/1.12 + (11,000,000/0.12) / 1.12

= $57,595,238.09

C.) per share price if company undertakes investment :

(Net present value of growth opportunities / number of stocks outstanding)

= $57,595,238.09 / 20,000,000

= $2.88

Hence,

[Per share value of growth opportunities + per share value of car map y does not undertake new investment]

[$2.88 + $35.42]

= $38.30