Problem:
Acme Fixtures expects net cash flows at year 1 of $500,000. These net cash flows will grow 3% per year forever if the firm makes no new investments. Assume the net cash flows will be paid as dividends. The President of Acme has the opportunity to add a line of kitchen and bathroom cabinets to the business. The immediate outlay (at time 0) for this opportunity is $1m and the net cash flows from the line will begin one year from now. The cabinet business will generate $320,000 in additional net cash flows at time 1. These net cash flows will also grow forever at a rate of 3%. As before, assume the net cash flows will be paid as dividends. The firm's discount rate for its current line of business and the cabinet business is 13%, and 2m shares of Acme stock are outstanding.
SHOW ALL EXCEL SPREADSHEETS AND FORMULAS
1) What is the price per share of Acme stock without the cabinet business?
2) Once Acme announces that they will add the cabinet line, what is the price of Acme stock?
3) Assume that Acme raises $1m required to take on the new cabinet by issuing new shares of stock. How many shares does Acme need to issue and at what price? Who benefits from the project, the new shareholders, the old shareholders, both, or neither?
4) Would Acme wish to issue the new stock before or after the announcement of the new cabinet business? Why?