You purchased 100 shares in an oil company, Vic Energy Ltd at the price of $50/share.

The company has 1 million shares outstanding. Ten days later Vic Energy announced an investment in an oil field in east Victoria.

The probability that the investment will be successful and generate an NPV of $10 million is 0.2;

The probability that the investment will be a failure and generate a negative NPV of negative $1 million is 0.8.

How would you expect the share price?

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Expert Solution

The total number of shares outstanding- 1 million

Current market price- $ 50/ share

The market capitalization is - $50x1 = $50 million

Lets assume, the company's net debt = 0

Therefore, the enterprise value will be= market capitalization + net debt

= $50 million

The probability that the investment will be successful and generate an NPV of $ 10 million is 0.2

Therefore the investment will go up by $10 x 0.2 = $2 million

The probability that the investment will be failure and generate a negative NPV of $1 million is 0.8

Therefore the investment will fall by $1 x 0.8 = $0.8 million

The net Investment will go up by = $2 -$0.8 = $1.2 million

In the Future, the possibility that the enterprise value would be increased by $ 1.2 million

Therefore, the intrinsic enterprise value would be = $50 + $1.2 = $51.2 million

The intrinsic equity value would be = $51.2 million

The expected share price would be = $51.2 / 1 = $51.2 /share

jeff jeffy answered 1 year ago

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