investors have learned that Richmond expects to earn free cash flows of $11 million each year in perpetuity. Richmond has 5 million shares outstand assets or opportunities. Suppose the appropriate discount rate for Richmond's future free cash flows is 6%, and the only capital market imperfection

investors have learned that Richmond expects to earn free cash flows of $11 million each year in perpetuity. Richmond has 5 million shares outstand assets or opportunities. Suppose the appropriate discount rate for Richmond's future free cash flows is 6%, and the only capital market imperfection

Exploring Economics

8th Edition

ISBN:9781544336329

Author:Robert L. Sexton

Publisher:Robert L. Sexton

Chapter16: The Markets For Labor, Capital, And Land

Section: Chapter Questions

Problem 12P

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Question

b. What is Richmond's share price today?
Suppose Richmond borrows the $50 million instead and thus there are only 3.5 million shares outstanding. The firm will pay interest only on this loan each year, and
maintain an outstanding balance of $50 million on the loan. Suppose that Richmond's corporate tax rate is 40% and expected free cash flows are still $11 million
c. What is Richmond's share price today if the investment is financed with debt?
each year.
Now suppose that with leverage, Richmond's expected free cash flows will decline to $10 million per year due to reduced sales and other financial distress costs.
Assume that the appropriate discount rate for Richmond's future free cash flows is still 6%.
d. What is Richmond's share price today given the financial distress costs of leverage?

Richmond Industries issued 1.5 million new shares of equity to raise $50 million to finance a new investment. The equity just started trading on the stock market and
investors have learned that Richmond expects to earn free cash flows of $11 million each year in perpetuity. Richmond has 5 million shares outstanding, and no other
assets or opportunities. Suppose the appropriate discount rate for Richmond's future free cash flows is 6%, and the only capital market imperfections are corporate
taxes and financial distress costs.

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