Question

Input Area

Shares outstanding 8,700,000
Share price $46.50
Purchase price of land $65,000,000
Perpetual earnings increase $14,000,000
Current cost of capital 12.50%
Cost of new debt 8%
Optimal equity weight 70%
Optimal debt weight 30%
Tax rate 21%


Output area:

1. If Stephenson wishes to maximize its total market value, would you recommend that it issue debt or equity to finance the land purchase? Explain.




Assets ?? Equity??
Total assets?? Debt & Equity ??

Perpetual aftertax earnings??

NPV of purchases??

3. Balance Sheet
Old assets??
NPV of Project?? Equity??
Total assets?? Debt & Equity ??
New share price? ?
Shares to issue? ??

4. Balance Sheet
Cash???
Old assets??
NPV of project?? Equity ??
Total assets ?? Debt & Equity ??

Total shares outstanding ? ?

Share price ?? ?

PV of earnings increase ?? ?

Balance Sheet
5. Old assets??
PV of project ??? Equity ?? ?
Total assets ?? ? Debt & Equity ??? ?

Value of levered company ?? ? <---VL = VU+TC*D Note*: TC = Tax rate

Balance Sheet
Value unlevered?? ? Debt ?? ?
Tax shield value?? ? Equity ?? ?
Total assets ?? ? Debt & Equity ?? ?

Stock share price???

6. Which method of financing maximizes the per share stock price of Stephenson's equity?

Answer 1

1. If Stephenson wishes to maximize its total market value, it should issue debt to finance the land purchase. This is because the cost of debt is lower than the cost of equity, which means that issuing debt will result in a lower overall cost of capital for the company. This, in turn, will increase the value of the company and maximize its total market value.

2.
- Assets: $65,000,000 (purchase price of land)
- Equity: $405,450,000 ($46.5 x 8,700,000)
- Total assets: $470,450,000 ($65,000,000 + $405,450,000)
- Debt & Equity: $470,450,000

- Perpetual aftertax earnings: $14,000,000 / (1 - 0.21) = $11,060,000

- NPV of purchases: -$65,000,000

3.
- Old assets: $405,450,000
- NPV of Project: -$65,000,000
- Equity: $340,450,000 ($405,450,000 - $65,000,000)
- Total assets: $470,450,000 ($405,450,000 + $65,000,000)
- Debt & Equity: $470,450,000

- New share price: $40.41
- Shares to issue: 1,607,166.24

4.
- Cash: -$65,000,000
- Old assets: $405,450,000
- NPV of project: -$65,000,000
- Equity: $275,450,000 ($340,450,000 - $65,000,000)
- Total assets: $340,450,000 ($405,450,000 - $65,000,000)
- Debt & Equity: $275,450,000

- Total shares outstanding: 8,700,000
- Share price: $31.67
- PV of earnings increase: $175,000,000 / 0.125 = $1,400,000,000

- Old assets: $405,450,000
- PV of project: -$65,000,000
- Equity: $340,450,000
- Total assets: $740,450,000 ($405,450,000 - $65,000,000 + $400,000,000)