Question

Golf Ball Inc. expects earnings to be $10,000 per year in perpetuity if it pays out all of its earnings in dividends. Suppose the firm has an opportunity to invest $1,000 of next year's earnings to upgrade its machinery. It is expected that this upgrade will increase earnings in all future years (starting two years from now) by $140. Assume that Golf Ball's next dividend is one year from now. The required rate of return is 12%.
What is the value of Golf Ball Inc. if it undertakes the upgrade?

Answer 1

Answer: $ 83,333.33

Explanation:

Based on the information given, the value of Golf Ball Inc. if it undertakes the upgrade will be:

It should be noted that the earning will be distributed as dividend if there's no upgrade. Hence, dividend will be $10000.

Since the required rate of return is 12%, then the value of Golf Ball Inc. if it undertakes the upgrade will be:

= Dividend / required rate of return

= 10000 / 12 %

= 10000 / 0.12

= $ 83,333.33