Growth Opportunities – The Stambaugh Corporation currently has earnings per share of $8.25. The company has no growth and pays out all earnings as dividends. It has a new project which will require an investment of $1.60 per share in one year. The project is only a two – years following the investment by $2.10 and $2.45, respectively. Investors require a 12% return on Stambaugh stock.
what is the value per share of the company’s stock assuming the firm does not undertake the investment opportunity?
P = Dividend / R
P = $8.25 / 0.12
P = $68.75
if the company does undertake the investment, what is the value per share now?
The investment is a one – time investment that creates an increase in EPS for two years. To calculate the new stock price, we need the cash cow price plus the NPVGO.
NPVGO = C1 / (1+R) + C2/(1+R)2 + C3/(1+R)3
NPVGO = -$1.60/ 1.12 + $2.10/1.122 +$2.45/1.123
NPVGO = $1.99
P = $68.75 + $1.99
P = $70.74
again, assume the company undertakes the investment. What will the price per share be four years from today?
After the project is over, and the earning increase no longer exists, the price of the stock will revert back to $68.75, the value of the company as a cash cow.
Reference: Chapter 9, Corporate Finance Book, Stephen A.Ross, Randolph W.Westerfield and Jeffrey Jaffe, Ninth Edition.
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