A start-up company Amazonian.com is considering expanding into new product markets. The expansion will require an initial investment of $160 million and is expected to generate perpetual EBIT of $40 million per year. After the initial investment, future capital expenditures are expected to equal depreciation, and no further additions to net working capital is anticipated. Amazonian.com’s existing capital structure is composed of equity with a market value of $500 million and debt with a market value of $300 million, and has 10 million shares outstanding. The unlevered cost of capital for Amazonian.com is 10%, and Amazonian.com’s debt is risk free with an interest of 4%. The expansion into the new product market will have the same business risk as Amazonian.com’s existing assets. The corporate tax rate is 35%, there are no personal taxes or costs of financial distress. a) Amazonian.com initially proposes to fund the expansion by issuing equity. If investors were not expecting this expansion, and if they share Amazonian.com’s view regarding expansion’s profitability, what will the share price be once the firm announces the expansion plan? b) Suppose investors think that the perpetual EBIT from Amazonian.com’s expansion will be only $4 million per year. What will the share price be in this case? How many shares will the firm need to issue to finance the project?
A start-up company Amazonian.com is considering expanding into new product markets. The expansion will require an initial investment of $160 million and is expected to generate perpetual EBIT of $40 million per year. After the initial investment, future capital expenditures are expected to equal depreciation, and no further additions to net working capital is anticipated. Amazonian.com’s existing capital structure is composed of equity with a market value of $500 million and debt with a market value of $300 million, and has 10 million shares outstanding. The unlevered cost of capital for Amazonian.com is 10%, and Amazonian.com’s debt is risk free with an interest of 4%. The expansion into the new product market will have the same business risk as Amazonian.com’s existing assets. The corporate tax rate is 35%, there are no personal taxes or costs of financial distress. a) Amazonian.com initially proposes to fund the expansion by issuing equity. If investors were not expecting this expansion, and if they share Amazonian.com’s view regarding expansion’s profitability, what will the share price be once the firm announces the expansion plan? b) Suppose investors think that the perpetual EBIT from Amazonian.com’s expansion will be only $4 million per year. What will the share price be in this case? How many shares will the firm need to issue to finance the project?
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
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A start-up company Amazonian.com is considering expanding into new product markets. The expansion will require an initial investment of $160 million and is expected to generate perpetual EBIT of $40 million per year. After the initial investment, future capital expenditures are expected to equal depreciation , and no
further additions to net working capital is anticipated. Amazonian.com’s existing capital structure is composed of equity with a market value of $500 million and debt with a market value of $300 million, and has 10 million shares outstanding. The unlevered cost of capital for Amazonian.com is 10%, and Amazonian.com’s debt is risk free with an interest of 4%. The expansion into the new product market will have the same business risk as Amazonian.com’s existing assets. The corporate tax rate is 35%, there are no personal taxes or costs of financial distress.
a) Amazonian.com initially proposes to fund the expansion by issuing equity. If investors were not expecting this expansion, and if they share Amazonian.com’s view regarding expansion’s profitability, what will the share price be once the firm announces the expansion plan?
b) Suppose investors think that the perpetual EBIT from Amazonian.com’s expansion will be only $4 million per year. What will the share price be in this case? How many shares will the firm need to issue to finance the project?
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