Malcolm, a very junior reporter, has asked for your help with his first article for a major national newspaper. He has provided you with the following excerpt from his article and would like your comments:
The BathGate Group, one of the few all-equity firms left in Canada, has recently built a widget manufacturing plant in Whitby. The firm has invested $1 million and, according to our sources, the promised return on the investment (IRR) is over 27 percent! The shareholders of the firm must be ecstatic—they are currently only receiving a return of 10 percent. Just think—in 10 years the value of the plant is expected to be close to $11 million.
a. What is Malcolm assuming about the reinvestment rate? Does it make sense?
b. What is Malcolm assuming about the riskiness of the project? Are the shareholders necessarily happy with this decision?