Question 1

a) A company is expanding into a new product range. Current earnings per share is 6. In the coming year the growth rate before the new product range was expected at 6%, annually. With the new investment the growth rate is expected to increase to 8.4%. To finance this investment the payout would need to be cut from 96% to 60%. Equity cost of capital is 13.2% and is expected to remain unchanged. What is the impact of this new policy on the firms share price?

b) Discuss three (3) usefulness and three (3) limitations of balance sheets in estimating a firms value.

c) Super Pharmacy has just announced the development of a new drug for which the company is seeking approval from the Food and Drug Administration (FDA). If approved, the future profits from the new drug will increase Super Pharmacy market value by $1,125 million, Super Pharmacy has 75 million shares outstanding. If the development of this drug was a surprise to investors, and if the average likelihood of FDA approval is 15%, what do you expect will happen to the stock price when this news is announced? What may happen to the stock price over time?