Wyatt Oil just reported that a major fire destroyed one of its oil production facilities in Colorado.While the facility was fully insured,the loss of oil production will decrease Wyatt's free cash flow by $120 million at the end of this year and by $80 million at the end of next year.Wyatt has 50 million shares outstanding and has a weighted average cost of capital of 9%.Assuming the value of Wyatt's debt is not affected by this event,the expected decrease in Wyatt's stock price is closest to:

Question

Quizplus · Accepted Answer

To calculate the expected decrease in stock price, we need to find the present value of the decrease in free cash flows, which is $120 million this year and $80 million next year. Using the formula for present value of growing perpetuity, we get:

PV = (FCF / (WACC - g))

where FCF is free cash flow, WACC is weighted average cost of capital, and g is the expected growth rate of FCF.

Since the decrease in FCF is expected to continue into the future, we assume a constant growth rate of 0%. Plugging in the numbers, we get:

PV = (120 / (0.09 - 0)) + (80 / (0.09 - 0))
   = 1,333.33 + 888.89
   = 2,222.22

Dividing the present value by the number of shares outstanding, we get the expected decrease in stock price:

Expected decrease = PV / Shares
                  = 2,222.22 / 50
                  = 44.44 cents

Therefore, the expected decrease in Wyatt's stock price is closest to $3.55, which is answer choice B.

Wyatt Oil Just Reported That a Major Fire Destroyed One