Longlife Company is considering an investment in Ponce Leon Mineral Baths. The investment has the same risk characteristics as the firm. It is assumed that all cash flows are perpetuities and that there are no taxes. Currently the firm has cash flows of $1,000 a year with required debt payments of $300 per year. The current market value of the firm (debt plus equity) is $13,000. The firm is considering an investment of $5,000 in a project that will generate $610 a year forever. Assume that the firm can continue to borrow at 5 percent.
a. Should the firm undertake the investment?
b. Demonstrate that the investment will increase/decrease shareholder value (show the impact on cash flows to debt holders and equity holders).

  • CreatedFebruary 25, 2015
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