Question

Sarro Shipping, Inc., expects to earn $1.3 million per year in perpetuity if it undertakes no new investment opportunities. There are 120,000 shares of stock outstanding, so earnings per share equal $10.83 ($1,300,000/120,000). The firm will have an opportunity at date 1 to spend $1,200,000 on a new marketing campaign. The new campaign will increase earnings in every subsequent period by $240,000 (or $ 2 per share). The firm’s discount rate is 10 percent. What is the value per share before and after deciding to accept the marketing campaign?

Answer 1

Given,

Stock outstanding = 120000 shares

Earnings per share = $10.83

Spend at date 1 = $1200000

Incremental earnings = $240000

Discount rate = 10% or 0.10

Solution :-