Question

Carbondale Oil announces that a wildcat well that it has sunk in a new oil province has shown the existence of substantial oil reserves. The exploitation of these reserves is expected to increase Carbondale's free cash flow by $90 million per year for eight years. If investors had not been expecting this news, what is the most ikely efflect on Carbondale's stock price upon the announcement, given that Carbondale has 80 million shares outstanding, no debt, and an equity cost of capital of 8%? O A. rise by $7.76 O B. rise by $6.46 OC. rise by $5.17 O D. no effect

Answer 1

Answer:

B. rise by $6.46

Explanation:

For computing the increase per share, first we have to compute the present value of cash flows which is shown below:

The present value of cash flows = Free cash flows × present value factor for 8 years at 8%

= $90,000,000 × 5.7466

= $517,194,000

Refer to the present value interest factor table (PVIFA table)

Now increase per share would be

= Present value of cash flows ÷ number of outstanding shares

= $517,194,000 ÷ 80,000,000 shares

= $6.46