Management has informed the market that it expects to earn 30% on project A and 40% on project B, and these expectations are already baked into the firm's current stock price. The cost of capita] for both projects is 10%. The amount of investment required for project A is $5 million, and project B requires $30 million. Just before it is about to invest in project B, the company learns that the expected rate on the project will be 30%, not 40%.
Table Q13.2 Data for Q13.2

(a) Should management still make the investment in project B?
(b) What will happen to the company's stock price if management invests in B?
(c) What will happen to the stock price if management does not invest in B?

Transcribed Image Text:

(a) Debottleneck 10% $1,000 400 500 500 500 Base Case 10% 1,000 (b) Cut Costs 10% $1.000 (c) Sell for 10% Premium 10% $1,000 WACC CF CF2 CF3 Sale price 300 S300 S300 350 350 350 S1,100