Sarro Shipping Inc., expects to earn $1 million per year in perpetuity if it und

Question

Sarro Shipping Inc., expects to earn $1 million per year in perpetuity if it undertakes no new investment opportunities. There are 100,000 shares of stock outstanding, so earnings per share equal $10 (that is, 1,000,000/100,000). The firm will have an opportunity at date 1 to spend $1,000,000 in a new marketing campaign. The new campaign will increase earnings in every subsequent period by $210,000 (or $2.10 per share). This is a 21% return per year on the project. The firm’s discount rate is 10%. What is the value per share of Sarro Shipping before and after deciding to accept the marketing campaign?

Explanation / Answer

Sarro Shipping Inc. Value per share before marketing campaign Earning per year for perpetuity=$1,000,000 Discount rate =10% Enterprise value =1000000/10%=     10,000,000 No of common stock outstanding           100,000 Value per share before marketing campaign= $         100.00 ( assuming only equity funding ) Value per share After marketing campaign Earning per year for perpetuity=$1,210,000 Discount rate =10% Enterprise value =1,210,000/10%=     12,100,000 No of common stock outstanding           100,000 Value per share after marketing campaign= $         121.00

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