Answer:
Change in Share price = $0.10
Explanation:
Formula for current value of firm:
Current value of firm = Perpetual Cash flow/Discount rate
As Lasko's has 250,000 shares of stock outstanding, $400,000 in perpetual annual earnings, and a discount rate of 16 percent.
Therefore by putting the values in the above formula, we get
Current Value of firm = 400,000 / 0.16
Current Value of firm = $2,500,000
Formula for Per share value:
Per share value = Current value of firm / Number of shares outstanding
As Current Value of firm = $2,500,000 and Lasko's has 250,000 shares of stock outstanding
Therefore by putting the values in the above formula, we get
Per share value = $2,500,000 / 250,000
Per share value = $10 per share
Formula for value of perpetual cashflows:
Value of perpetual cashflow = annual perpetual cash flows / discount rate
As the firm is considering a new project that has initial costs of $350,000 and annual perpetual cash flows of $60,000.
Therefore by putting the values in the above formula, we get
Value of perpetual cashflows from project today = 60,000 / 0.16 = $375,000
Formula for new Value of firm:
New Value of firm = Initial value - Investment for project + Value generated from project
New Value of firm = 2,500,000 - 350,000 + 375,000
New Value of firm = $2,525,000
New value per share = $2,525,000/250,000
New value per share = $10.10
Formula for Change in Share price:
Change in Share price = New value per share - Per share value
Therefore by putting the values in the above formula, we get
Change in Share price = $10.10 - $10
Change in Share price = $0.10
