Question

AMS Company has unexpectedly generated a​ one-time extra ​$6 million in cash flow this year. After announcing the extra cash​ flow, AMS stock price was ​$60 per share​ (it has 1 million shares​ outstanding). The managers are considering spending the ​$6 million on a project that would generate a single cash flow of ​$6.5 million in one​ year, which they would then use to repurchase shares. Assume the cost of capital for the project is 12​%.

a. If they decide on the​ investment, what will happen to the price per​ share?

b. If they instead use the ​$6 million to repurchase stock​ immediately, what will be the price per​ share?

c. Which decision is better and​ why?

Homework: Payout Ch17 Score: 0 of 1 pt 10 of 10 (9 complete) HW Score: 90%, 9 of P 17-17 (similar to) EQuestion Hclp AMS Company has unexpectedly generated a one-lime edra $6 million in cash Bow this year Ater announcing he extra cash fow, AMS slock price was $60 per share (t has 1 million shares outstanding) 1he managers are considering sponding the $6 million on a project that would generate a single cash flow oll $6.5 million in one year, which they would then use to repurchase shares. Assume the cost of capital for the project is 12% a. If they decide on the investment, what will happen to the price per share? b. If they instead use the $6 million to repurchase stock immediatoly, what will be the price per share? c. Which dechion is better and why? a. If they decide on the investment, the price per share wll be S (Round to the nearest cent)

Answer 1

a) If they decide to investment, PV of future cash flows = $6.5 / (1 + 12%) = $5.80 million.

Stock Price = 60 + 5.8 / 1 = $65.80

b) If they repurchase the stock immediately, Stock Price = 60 + 6 / 1 = $66.00

c) Repurchase immediately is better.