Question: Rite Bite Enterprises sells toothpicks. Gross revenues last year were $3 million, and total costs were $1.5 million. Rite Bite has 1 million shares of common stock outstanding. Gross revenues and costs are expected to grow at 5 percent per year. Rite Bite pays no income taxes. All earnings are paid out as dividends.
a. If the appropriate discount rate is 15 percent and all cash flows are received at year's end, what is the price per share of Rite Bite stock?
b. Rite Bite has decided to produce toothbrushes. The project requires an immediate outlay of $15 million. In one year, another outlay of $5 million will be needed. The year after that, earnings will increase by $6 million. That profit level will be maintained in perpetuity. What effect will undertaking this project have on the price per share of the stock?