TLP corporation had operating cash flow of $3.20 per share last year, and has 1.5 million shares outstanding. Operating cash flows are expected to grow by 4% per year in the long run, i.e. forever. To attain this growth, TLP will need to make new capital expenditures in an amount equal to 40% of each year’s operating cash flow. TLP also has existing liabilities with a market value of $3 million.
(a) If TLP has no other assets, and a discount rate of 13% per year is appropriate, what is the fair market value of a share of TLP stock?
(b) Assume now that TLP has just made a breakthrough in biomedical engineering. The new project will require an immediate capital expenditure of $2.5 million, plus another $3.2 million outlay after one year. At the end of the second year the project will generate positive cash flow of $1.6 million. Subsequent cash flows from the project will grow by 4% per year in perpetuity. Given that TLP has made this breakthrough, and still assuming a 13% discount rate, what is the fair market value of a share of TLP stock?