Reference no: EM132819985

Suppose we operate a real estate development company which constructs 5income producing properties per year. Current labor and raw material costs total $20million per unit and are expected to increase in direct relation to the overall rate of inflation. Sales revenues (currently $26million per unit) are not currently subject to any long-term contracts, and thus, will also be expected to instantaneously adjust to any changes in the overall price level. If investors require a real return of 4%, inflation is expected to be 3% per year in perpetuity, and the firm currently has 10,000,000 shares of common stock outstanding, what should be the current market price of each share of stock?

Continuing from problem above, now suppose you are approached by your raw materials supplier. They are looking to reduce risk throughout their supply chain, and would like to increase the certainty of their cashflows. Toward this end, they offer you the opportunity to enter into a three-year, fixed price contract that will lock in today's prices of raw material inputs for the next three years. You estimate one-half of your total production costs come from raw materials, while the remaining one-half are due to labor costs which will remain unaffected by this contract offer. At the expiration of the three year contract, raw material prices will re-adjust to their true market values (i.e., any lost prices increases will be instantaneously added to prices -a potentially large jump). Assuming you are a risk-neutral, profit maximizing investor, what is the value of this fixed-price contract offer to the firm?