Question
The annual earnings of BouncingBall Tennis will be $5 a share in perpetuity if the firm makes no new investments (and therefore pays out all
The annual earnings of BouncingBall Tennis will be $5 a share in perpetuity if the firm makes no new investments (and therefore pays out all its earnings as dividends). BouncingBall has a one-time opportunity, occurring three years from now, to invest 25% of its earnings (at that time) in a new project. For each dollar invested, earnings will be $0.40 higher in each subsequent year (in perpetuity) than they would have been otherwise. Assume that the discount rate is 14%.
(a) What is the price per share of BouncingBall Tennis stock today, without making the new investment?
(b) What is the price if the new investment is made?
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