Question: Kumar expected his firm to earn $ 1 , 0 0 0 per year forever, with no growth. Given a cost of capital of 1

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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