Question

Marco Production had a current share price of $79, and the firm had 1,200,000 shares of stock outstanding. The company is considering an investment project that requires an immediate $16,000,000 investment but will produce cash flows of $4,700,000, $5,100,000, $8,700,000, and $7,200,000 in years 1 to 4, respectively. The aftertax salvage value when the project closes is $1,200,000. If Marco Production invests in the project, what would the new share price be? Marco Production's cost of capital is 15%. (Hint: consider how the project NPV affects the stock price)

Answer 1

The new share price is computed as shown below:

The NPV is computed as shown below:

= Initial investment + Present value of future cash flows

Present value is computed as follows:

= Future value / (1 + r)ⁿ

So, the NPV is computed as follows:

= - $ 16,000,000 + $ 4,700,000 / 1.15 + $ 5,100,000 / 1.15² + $ 8,700,000 / 1.15³ + $ 7,200,000 / 1.15⁴ + $ 1,200,000 / 1.15⁴

= $ 2,466,407.71

So, the new share price will be as follows:

= current price + NPV / Number of shares

= $ 79 + $ 2,466,407.71 / 1,200,000

= $ 81.06 Approximately

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