Richmond Industries issued 1.5 million new shares of equity to raise $45 million to finance a new investment. The equity just started trading on the stock market and investors have learned that Richmond expects to earn free cash flows of $9 million each year in perpetuity. Richmond has 5 million shares outstanding, and no other assets or opportunities. Suppose the appropriate discount rate for Richmond's future free cash flows is 6%, and the only capital market imperfections are corporate taxes and financial distress costs.

a. What is the NPV of Richmond's investment?

b. What is Richmond's share price today? Suppose Richmond borrows the $45 million instead and thus there are only 3.5 million shares outstanding. The firm will pay interest only on this loan each year, and maintain an outstanding balance of $45 million on the loan. Suppose thatRichmond's corporate tax rate is 40% and expected free cash flows are still $9 million each year.

c. What is Richmond's share price today if the investment is financed with debt? Now suppose that with leverage, Richmond's expected free cash flows will decline to $8 million per year due to reduced sales and other financial distress costs. Assume that the appropriate discount rate for Richmond's future free cash flows is still 6%.

Answer rating: 100% (QA)

a The PV of future cash flows from Richmonds investment free cash flow till ... View the full answer