Growth Opportunities The annual earnings of Avalanche Skis will be 6 Swedish kroner 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 per cent of its earnings in new projects. Each project will earn 40 per cent at yearend in perpetuity. The firm’s discount rate is 14 per cent.

(a) What is the share price of Avalanche Skis today without the company making the new investment?

(b) If Avalanche announces that the new investment will be made, what will the share price be today?

CHALLENGE