One firms investment using its asset in place can generate EPS $10 every period forever. The investor
Question:
One firm’s investment using its asset in place can generate EPS $10 every period
forever. The investor compound annually with the rate of return 10%.
(a) If the firm has no positive NPV investment opportunities in the future. What is
the price of the firm’s stock?
(b) If the firm has only one growth opportunity in period t = 3. The firm has to
use the cash generated by the asset in place to pay the initial investment costs
of the new growth opportunity. The new growth opportunity requires $2 initial
investment and will generate 20% return every period forever. What is the PVGO?
What is the stock price?
(c) Suppose the firm will have the investment opportunity every period from t = 1 on. The firm decides to use 20% of its earning for the new investment in every period. Every new investment will generate 20% return every period from the next period on. That is, the investment in t = 1
costs $2 and will generate $0.4 cash flow every period from t = 2 on. Note, 20%
of TOTAL earning in t = 2 will be used for the new investment. (Don’t forget the $10 generated by the asset in place.) What is the firm’s dividend growth rate,
g? What is the stock price? What is PVGO?