Question

Rite Bite Enterprises sells toothpicks. Gross revenues last year were $8.0 million, and total costs were $3.9 million. Rite Bite has 1.2 million shares of common stock outstanding. Gross revenues and costs are expected to grow at 4 percent per year. Rite Bite pays no income taxes. All earnings are paid out as dividends. (Do not round intermediate calculations and round your answers to 2 decimal places. (e.g., 32.16))

a. If the appropriate discount rate is 14 percent and all cash flows are received at year’s end, what is the price per share of Rite Bite stock? $35.53
b. Rite Bite has decided to produce toothbrushes. The project requires an immediate outlay of $17.5 million. In one year, another outlay of $6.5 million will be needed. The year after that, earnings will increase by $4.7 million. That profit level will be maintained in perpetuity. What will the new stock price be if the project is undertaken?

Answer 1

a. Calculation of PV of the gross revenue

PV(revenue) = $8,000,000*(1+4%) / (14%-4%) = $83,200,000

Calculation of PV of the total cosst

PV(revenue) = $3,900,000*(1+4%) / (14% - 4%) = $40,560,000

Since there is no tax, the Pv of divided will be: Dividend = $83,200,000-$40,560,000 = $42,640,000

Calculation of price per share

Price per share = Present value dividend / Share outstanding = $42,640,000 / 1,200,000 = $35.53

b. Increase in Stock prcie= (-Immediate outlay - Another outlay next year/1.14 + (Increase in Earning in year 2/14%)/1.14)/Outstanding Share

Increase in Stock price= (-17.5 -6.5/1.14 + (4.7/14%)/1.14)/1.2

Increase in Stock price = $5.21

New stock price = $35.53 + 5.21

New stock price = $40.74