Essentials Of Investments
11th Edition
ISBN: 9781260013924
Author: Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher: Mcgraw-hill Education,
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Transcribed Image Text:"We R Toys" (WRT) is considering expanding into new geographic markets. The expansion will have the same business risk as WRT's existing assets. The expansion will require an initial investment
of $50 million and is expected to generate perpetual EBIT of $20 million per year. After the initial investment, future capital expenditures are expected to equal depreciation, and no further additions
to net working capital are anticipated.
WRT's existing capital structure is composed of $450 million in equity and $225 million in debt (market values), with 10 million equity shares outstanding. The unlevered cost of capital is 9%,
and WRT's debt is risk free with an interest rate of 5%. The corporate tax rate is 40%, and there are no personal taxes.
a. WRT initially proposes to fund the expansion by issuing equity. If investors were not expecting this expansion, and if they share WRT's view of the expansion's profitability, what will the share price
be once the firm announces the expansion plan?
Once the firm announces the expansion plan, the share price will be $
per share. (Round to the nearest cent.)
b. Suppose investors think that the EBIT from WRT's expansion will be only $4 million. What will the share price be in this case? How many shares will the firm need to issue?
If investors think that the EBIT from WRT's expansion will be only $4 million, the share price will be $ per share. (Round to the nearest cent.)
The firm will need to issue million shares. (Round to two decimal places.)
c. Suppose WRT issues equity as in part (b). Shortly after the issue, new information emerges that convinces investors that management was, in fact, correct regarding the cash flows from the
expansion. What will the share price be now?
If WRT issues equity, then shortly after the issue, new information emerges that convinces investors that management was, in fact, correct regarding the cash flows from the expansion, the share
price will be $. (Round to the nearest cent.)
Why does it differ from that found in part (a)? (Select the best choice below.)
A. Shares in part (a) are not fairly valued and are fairly valued in part (b).
OB. Shares in part (a) are not fairly valued and are undervalued in part (b).
OC. Shares in part (a) are fairly valued and undervalued in part (b).
O D. Shares in part (a) are fairly valued and fairly valued in part (b).
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