Question

In a surprise announcement, NASA released details of a major contract with Lockheed-Martin (LMT) that would increase LMT's market value by $7.5 billion. It was widely expected by the market that this contract would be awarded to LMT's major competitor Boeing (BA). Assume that Boeing has 800 million shares outstanding and Lockheed Martin has 425 million shares outstanding. Prior to this announcement, the market felt that the probability of Boeing winning the contract was 90% and that Lockheed-Martin's chance was only about 10%. What do you anticipate will happen to Lockheed-Martin and Boeing's stock prices are a result of this surprise announcement? Show calculations.

Answer 1

Answer:

As given in the question: Lockheed -Martin(LMT)'s market value will increase by: $7.5 billion or $ 7500 millions

Prior to the announcement : the probability of Boeing winning the announcement was 90% while that of LMT was 10%.

So, after the announcement :

Since most of the people had expected Boeing to win the contract but LMT has won the contract and as a result of this surprise announcement , the stock price of LMT will increase in anticipation of the increased profits that LMT will incur on account of this deal.

This increase will be given by:

Increase in LMT's stock prices :[(Increase in market Value*Probability of Boeing winning the contract(since LMT's stock price did not have the probability of it wining the contract incorporated)]/Number of outstanding shares

As given :

Increase in Market Value of LMT : $ 7500 millions

Probability of Boeing wining the contract : 90% or .90

Number of outstanding shares of LMT : 425 million shares outstanding

Putting these into the formula , we get:

Increase in LMT's Stock Prices: [$7500*.90]/425 ie. 15.88 increase in LMT's stock prices.

Again most of the market had expected Boeing to win the contract but since LMT has won it so Boeing's stock price will decline:

Decline in Boeing's Stock Price:[ Increase in LMT's market Value*Probability of Boeing wining the contract]/Number of outstanding shares of Boeing

As given:

Number of outstanding shares of Boeing= 800

Substituting this and the other values as mentioned earlier in this formula we get:

Decline in Boeing's Stock Price= [$7500*.90]/800 ie. 8.44 decrease in price of Boeing's stock price.