Company A, today expects to earn $8.50 per share for each of the future operating periods...

Company A, today expects to earn $8.50 per share for each of the future operating periods (beginning at Time 1), today if the firm makes no new investments and returns the earnings as dividends to the shareholders. However, the CEO has discovered an opportunity to retain and invest 20 percent of the earnings beginning three years from today. This opportunity to invest will continue for each period indefinitely. He expects to earn 10 percent on this new equity investment, the return beginning one year after each investment is made. The firm’s equity discount rate is 12 percent.

a. What is the price per share of Company A's stock without making the new investment?

b. If the new investment is expected to be made, per the preceding information, what would the price of the stock be now?

c. Suppose the company could increase the investment in the project by whatever amount it chose. What would the retention ratio need to be to make this project attractive?

Expert Solution

jeff jeffy answered 2 years ago

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