Lasko's has 250,000 shares of stock outstanding, $400,000 in perpetual annual earnings, and a discount rate of 16 percent. The firm is considering a new project that has initial costs of $350,000 and annual perpetual cash flows of $60,000. How many new shares must be issued to fund the new project? Ignore taxes. A) 34,653 B) 33,928 C) 35,000 D) 36,028 E) 34,209

Change in Share price = $0.10

Explanation:

Formula for current value of firm:

Current value of firm = Perpetual Cash flow/Discount rate

As Lasko's has 250,000 shares of stock outstanding, $400,000 in perpetual annual earnings, and a discount rate of 16 percent.

Therefore by putting the values in the above formula, we get

Current Value of firm = 400,000 / 0.16

Current Value of firm = $2,500,000

Formula for Per share value:

Per share value = Current value of firm / Number of shares outstanding

As Current Value of firm = $2,500,000  and Lasko's has 250,000 shares of stock outstanding

Therefore by putting the values in the above formula, we get

Per share value = $2,500,000 / 250,000

Per share value = $10 per share

Formula for value of perpetual cashflows:

Value of perpetual cashflow = annual perpetual cash flows / discount rate

As the firm is considering a new project that has initial costs of $350,000 and annual perpetual cash flows of $60,000.

Therefore by putting the values in the above formula, we get

Value of perpetual cashflows from project today = 60,000 / 0.16 = $375,000

Formula for new Value of firm:

New Value of firm = Initial value - Investment for project + Value generated from project

New Value of firm = 2,500,000 - 350,000 + 375,000

New Value of firm = $2,525,000

New value per share = $2,525,000/250,000

New value per share = $10.10

Formula for Change in Share price:

Change in Share price = New value per share -  Per share value

Therefore by putting the values in the above formula, we get

Change in Share price = $10.10 - $10

Change in Share price = $0.10

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