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ABC Corp. has existing assets that generate earnings per share of $12.00. If the firm does not invest except to maintain existing assets, the earnings per share are expected to remain constant at $12.00 per year. However, starting next year the firm has a chance to invest $10.00 per share a year to develop a newly discovered geothermal steam source of electricity generation. These investments are expected to generate a permanent return of 12% per year. The resource is expected to be fully developed by the 5th year. The investors require a return of 10% if the firm maintains current operations.
a) What is the share price of ABC Corp. if it does not undertake the investment?
b) Suppose the geothermal project bears the same risk as ABC Corp.'s current business. Should ABC undertake this investment? Explain with supporting calculations.
c) If the geothermal project has a higher risk than ABC Corp.'s current business, will your conclusion in the previous part change? Explain with supporting calculations.
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