Question

Growth Opportunities Burklin, Inc., has earnings of $18 million and is projected to grow at a constant rate of 5 percent forever because of the benefits gained from the learning curve. Currently, all earnings are paid out as dividends. The company plans to launch a new project two years from now that would be completely internally funded and require 30 percent of the earnings that year. The project would start generating revenues one year after the launch of the project and the earnings from the new project in any year are estimated to be constant at $6.5 million. The company has 7.5 million shares of stock outstanding. Estimate the value of the stock. The discount rate is 10 percent.

Answer 1

Determine the current price of the stock:

It is given that the two different sources exist for the growth. They are learning curve and the new project. Hence, the current price of the stock should be determined separately using these sources.

In this source, the growth was about 5%. Using this growth, determine the EPS by dividing the earnings with the total number of outstanding shares as below:

Hence, the EPS for year 1 is $2.52.

Using the Net Present Value Growth Opportunities Model, the price of the share is calculated by discounting the earnings and adding the net present value of growth opportunities as below:

Now calculate the NPVGO of the new project that is expected to launch in two years. In this regard, the earnings per share two years from now should be calculated as below:

Hence, the EPS at the end of two years is $2.646.

Now calculated the initial investment by applying the required percentage on the EPS for the second year calculated as below:

Hence, the initial investment is $0.79.

Now calculate the earnings per share of the new project till perpetuity as below:

Hence, there is an increase of $0.87 per share in the EPS from the new project.

Now calculate the value of all future earnings in year 2, one year before the company realizes the earnings as below:

Now, calculate the NPVGO per share of the investment opportunity in year 2 as below:

Hence, the value of the NPVGO today is calculated as under:

As per the NPVGO Model, add the NPVGO and the price of stock to determine the current price of stock as below:

Hence, the current price of the stock is $56.91.