Viento Windmills is a utility that charges customers for their wind generated el

Question

Viento Windmills is a utility that charges customers for their wind generated electricity. With their current technology, they earn a total of $35 million each year to pay out to their 3 million shareholders. While their geographic footprint is fixed and we can't expect the climate to get progressively windier over time, they do have an opportunity to invest in technology that will more efficiently extract the wind energy and thus produce more megawatts to sell to customers. A one-time investment one year from now (t = 1) of $19 million for a state of the art lubricant system for the windmills will lead to extra cash flows that stay constant at $10 million per year starting the following year (t = 2) and lasting forever. If Viento plans to make the investment and cost of equity capital (the discount rate for equity) is 8.5%, calculate the increase or decrease in the share price of Viento as a result of this decision. Draw time line to understand what is going on

Explanation / Answer

Increase in valuation of firm in year 1 = 10/8.5% - 19

Increase in valuation of firm in year 1 = $ 98.64706 Million

Increase in Share Price in Year 1 = 98.64706/3

Increase in Share Price in Year 1 = $ 32.88

Increase in Share Price today = 32.88/1.085

Increase in Share Price today = $ 30.30

Answer

Increase in Share Price today = $ 30.30

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