The annual earnings of Avalanche Skis Inc. will be $10 per share in perpetuity if the firm

Question:

The annual earnings of Avalanche Skis Inc. will be $10 per share in perpetuity if the firm makes no new investments. Under such a situation, the firm would pay out all of its earnings as dividends. Assume the first dividend will be received exactly one year from now. Alternatively, assume that three years from now, and in every subsequent year in perpetuity, the company can invest 25 percent of its earnings in new projects. Each project will earn 15 percent at year-end in perpetuity. The firm’s discount rate is 13 percent.

a. What is the price per share of Avalanche Skis Inc. stock today without the company making the new investment?

b. If Avalanche announces that the new investment will be made, what will the per- share stock price be today?

Discount Rate
Depending upon the context, the discount rate has two different definitions and usages. First, the discount rate refers to the interest rate charged to the commercial banks and other financial institutions for the loans they take from the Federal... Dividend
A dividend is a distribution of a portion of company’s earnings, decided and managed by the company’s board of directors, and paid to the shareholders. Dividends are given on the shares. It is a token reward paid to the shareholders for their... Perpetuity
Perpetuity refers to payments that are made without an end or maturity date. A perpetuity is classified as an annuity, which is something that earns a dividend or receives a payment at a regularly scheduled interval, generally yearly. So, how...