Question

In: Finance

Anairline has a tendency to crash. As a result, passengers areconsidered to be less...

An airline has a tendency to crash. As a result, passengers are considered to be less likely to choose it. it is expected free cash flows will fall by $16 million per year for five years. If the airline has 45 million shares outstanding, an equity cost of capital of 12%, and no debt, how much would the companys shares be expected to fall in price as a result of this accident?

A. $1.14

B. $1.03

C.$1.28

D. $0.93

Solutions

Expert Solution

Price of Share = PV of Cashflows / No. of shares

PV of Cash flows:

PV of Annuity:

Annuity is series of cash flows that are deposited at regular intervals for specific period of time. Here cash flows are happened at the end of the period. PV of annuity is current value of cash flows to be received at regular intervals discounted at specified int rate or discount rate to current date.

PV of Annuity = Cash Flow * [ 1 - [(1+r)^-n]] /r
r - Int rate per period
n - No. of periods

Particulars Amount
Cash Flow $ 16,000,000.00
Int Rate 12.0000%
Periods 5

PV of Annuity = Cash Flow * [ 1 - [(1+r)^-n]] /r
= $ 16000000 * [ 1 - [(1+0.12)^-5]] /0.12
= $ 16000000 * [ 1 - [(1.12)^-5]] /0.12
= $ 16000000 * [ 1 - [0.5674]] /0.12
= $ 16000000 * [0.4326]] /0.12
= $ 57676419.24

Price per share = $ 57676419.24 / 45000000

= $ 1.28

OPtion C is correct.


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