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QuestionFullen Machinery invests \$400M in equipment with a \$700M future cash flow. How will this affect stock price from \$36? A. \$33.50 B. \$37.50 C. \$39.50

Studdy Solution

STEP 1

Assumptions1. The investment amount is 400million.Thepresentvalueoffutureafter−taxcashflowsfromtheequipmentis400 million. The present value of future after-tax cash flows from the equipment is 700 million3. Fullen has200 million shares of common stock outstanding4. The current market price per share is $365. The project is new information and is independent of other expectations about the company

STEP 2

First, we need to find the net present value (NPV) of the project. This is the difference between the present value of future cash flows and the investment.
NPV=Present value of future cash flows−InvestmentNPV = Present\, value\, of\, future\, cash\, flows - Investment

STEP 3

Now, plug in the given values for the present value of future cash flows and the investment to calculate the NPV.
NPV=$700 million−$400 millionNPV = \$700\, million - \$400\, million

STEP 4

Calculate the NPV.
NPV=$700 million−$400 million=$300 millionNPV = \$700\, million - \$400\, million = \$300\, million

STEP 5

The NPV is the increase in the value of the company due to the project. To find the increase in the stock price, we divide the NPV by the number of shares outstanding.
Increase in stock price=NPV/Number of shares outstandingIncrease\, in\, stock\, price = NPV / Number\, of\, shares\, outstanding

STEP 6

Plug in the values for the NPV and the number of shares outstanding to calculate the increase in the stock price.
Increase in stock price=$300 million/200 million sharesIncrease\, in\, stock\, price = \$300\, million /200\, million\, shares

STEP 7

Calculate the increase in the stock price.
Increase in stock price=$300 million/200 million shares=$1.5 per shareIncrease\, in\, stock\, price = \$300\, million /200\, million\, shares = \$1.5\, per\, share

STEP 8

Now that we have the increase in the stock price, we can add this to the current stock price to find the new stock price.
New stock price=Current stock price+Increase in stock priceNew\, stock\, price = Current\, stock\, price + Increase\, in\, stock\, price

STEP 9

Plug in the values for the current stock price and the increase in the stock price to calculate the new stock price.
New stock price=$36+$.5New\, stock\, price = \$36 + \$.5

STEP 10

Calculate the new stock price.
New stock price=$36+$.5=$37.5New\, stock\, price = \$36 + \$.5 = \$37.5The theoretical effect of the new equipment on Fullen's stock price is an increase to $37.50 per share.

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