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ABC Pharma produces an OTC drug and earns its entire revenue from it. ABC Pharma is 100% equity financed and is expected to earn $ 100 per share as profit in the coming year. Currently the firm earns a return on investment of 20% and has a retention ratio of 50% of earnings. The cost of equity of ABC Pharma is 15%. ABC Pharma is faced with a new investment opportunity which requires a one-time investment of $ 30 per share in year 1. This new project will generate a return of 5% on invested capital each year forever. The opportunity cost of this project is also 15%. ABC Pharma’s management will continue to invest in the older product as scheduled and the investment in the new project will be funded through a cut in dividend of $30. What is the value of ABC Pharma’s stock price today with this new project?

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Financial Management, Finance

Category:- Financial Management
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