Question: Kumar expected his firm to earn 1 000 per year forever
Kumar expected his firm to earn $1,000 per year forever, with no growth. Given a cost of capital of 10 percent, the value of the firm is $10,000. Kumar identified a new project, which costs $1,000 but would earn 11 percent per year forever. To invest in this project, Kumar cancelled this year’s dividend. Given that he is investing in a positive NPV project, he expected his stock to rise. However, it fell dramatically. Explain what happened. Does this mean that investors do not like positive NPV projects?
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