Question
Aqua Adventures currently generates net income of $500,000 every year, all of which is paid out in dividends, and expects no future growth. Aqua has
Aqua Adventures currently generates net income of $500,000 every year, all of which is paid out in dividends, and expects no future growth. Aqua has 200,000 shares outstanding, and investors require an 8% return on the company's shares. Assume that new management is hired to grow the company. One plan for the company is to invest its earnings of $500,000 per year for 1 year in a new project. If Aqua goes with the new project it will not be able to pay a dividend for the next year. However, the new project will increase net income to $570,000 in the second year and onward, all which will be paid out as dividends.
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Calculate the share price if the company maintains its current no-growth policy. Calculate the share price if the company goes with the new project. Briefly explain why
the share price has gone higher or lower.
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What must the minimum increase in net income be so that investors are equally well off
between its current no-growth policy and its proposed new project?
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