Mini Case Ch.16

Mini Case Ch.16

  • Submitted By: Jim-Reid
  • Date Submitted: 12/06/2014 9:04 PM
  • Category: Business
  • Words: 410
  • Page: 2

Jim Reid
Mini Case Ch.16

1. If Stephenson wishes to maximize its total market value, I would recommend that it issue debt to finance the land purchase. If they were to issue $45 million worth of debt to purchase the land, the interest payments along with the debt would be tax deductible, where debt in Stephenson’s capital structure will lower the taxable income of the company, which would make a tax shield that will raise the total value of the firm.

2. Market value balance sheet before it announces the purchase:

Common Stock Outstanding – 12 million shares
$48.50 Per Share

Market value of equity- 12 million*48.50= 582,000,000
All-equity firm, so all the stock is used.

Debt 0
Assets 582,000,000 Equity 582,000,000
Total assets $582,000,000 Total D&E $582,000,000

3. a. The NPV of the project would be:

Pretax earnings-$11 million per year, from the land purchase.
40% corporate tax rate

$11,000,000(1 - .40)=$6,600,000 After tax, there is an increase of the annual expected earnings.

All-equity firms use the unlevered cost of equity discount rate.
NPV= -45,000,000+(6,600,000/.115)

b. Market value of equity after the announcement:

Debt 0
Assets 582,000,000
NPV 12,391,304 Equity 594,391,304
Total assets $594,391,304 Total D&E $594,391,304

Market value of equity is different, so the stock price after the announcement will use the $594,391,304.

New Share Price= 594,391,304/12,000,000=$49.53

Need to issue=45,000,000/49.53= 908,540 shares
c. Market value balance sheet after the equity issue but before the purchase has ben made:

Cash 45,000,000 Debt 0
Assets 582,000,000
NPV 12,391,304 Equity 639,391,304
Total assets 639,391,304 Total D&E 639,391,304

Share of common stock outstanding= 12,000,000+908,504=12,908,504

Share price=639,391,304/12,908,504=49.43
No change in the stock price!

After tax present value of earnings inc.:...

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