Because of a catastrophic plane crash,the FAA announced that it is withdrawing its air worthiness certification for Fly by Night Aviation's (FBNA)new four-seat private plane.As a result,FBNA's future expected free cash flows will decline by $40 million a year for the next eight years.FBNA has 20 million shares outstanding,no debt,and an equity cost of capital of 12%.If this news is a complete surprise to investors,then the amount that FBNA's stock price should fall upon the announcement is closest to:
A)$2.00.
B)$16.00.
C)$16.70.
D)$9.90.

Question

Quizplus · Accepted Answer

The decline in future cash flows is $40 million per year for 8 years. The present value of this decline can be calculated using the formula for the present value of an annuity. The present value of the cash flow decline is $40 million * [(1 - (1 + 0.12)^-8) / 0.12] = $202.88 million. Dividing this by the 20 million shares outstanding gives a decrease in stock price of approximately $10.14, which is closest to $9.90.

Because of a Catastrophic Plane Crash,the FAA Announced That It