Question
An analyst knows with certainty that Skipper Inc. will exist for two years and have the following cash flows per share. Year 1 ($) Year
An analyst knows with certainty that Skipper Inc. will exist for two years and have the following cash flows per share.
Year 1 ($) | Year 2 ($) | |
Revenue | 100 | 100 |
Costs | 80 | 80 |
Net cash flow | 20 | 20 |
The problem is that Skipper Inc.s costs may not be $80 per share with certainty. Instead, each year there is a 10% chance that a worker will be seriously injured and that Skipper will have to pay the employees medical expenses and lost wages. In an injury does occur, Skippers costs equal $85 per share. If an injury does not occur (that has a probability of 0.9), then Skippers costs equal $79.445 per share.
A. What is Skippers expected net cash flow each year?
B. If the opportunity cost of capital is 8%, what is the stock price?
C. Provide an argument for why the opportunity cost of capital should not change because of the risk of worker injury.
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