Question

1. A startup corporation, COOL, has always lost money, but their product is popular with social media users. In a recent IPO, COOL sold its stock to the public for $20 a share. How is it possible for a company that that has never made any money to sell for a positive stock price? Explain.

2. You are saving for retirement and want to figure out how much you will need to save at the end of each year for the next 10 years so that you have $1,500,000 in time 30. The annual discount rate is 7% and you are using monthly compounding for your analysis (even though the payments are annual). Set up a calculation without solving.

3. Xtra Corp. stock is selling for $40 per share. The company has $1 million in cash to pay out to shareholders either (i) as a special dividend or (ii) through open-market repurchase. If there are 2,000,000 shares outstanding, what is the market value of equity after the transaction under choice (i) and choice (ii)? Explain

Answer 1

1]

It is possible for a company that that has never made any money to sell for a positive stock price.

The stock is valued by investors based on its expected future cash flows. A company which has always lost money may still be valued highly by investors because they expect the company to make money in the future. Thus, the potential future earnings of the company may be high enough to overlook the past losses.

As the product of COOL is popular with social media users, investors likely expect that the company will make profits in the future. Due to the expected potential profits, the stock price is positive, even though the company has always made losses.

For example, Spotify and Tesla are examples of publicly traded companies that command a high value for their stock price, even though they are loss-making companies