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Mini Case Essay

935 words - 4 pages

CHAPTER 16
STEPHENSON REAL ESTATE RECAPITALIZATION

1. If Stephenson wishes to maximize the overall value of the firm, it should use debt to finance the $45 million purchase. Since interest payments are tax deductible, debt in the firm’s capital structure will decrease the firm’s taxable income, creating a tax shield that will increase the overall value of the firm.

2. Since Stephenson is an all-equity firm with 12 million shares of common stock outstanding, worth $48.50 per share, the market value of the firm is:

Market value of equity = $48.50(12,000,000)
Market value of equity = $582,000,000

So, the market value balance sheet before the land purchase is:

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53

Since Stephenson must raise $45 million to finance the purchase and the firm’s stock is worth $49.53 per share, Stephenson must issue:

Shares to issue = $45,000,000 / $49.53
Shares to issue = 908,492

c. Stephenson will receive $45 million in cash as a result of the equity issue. This will increase the firm’s assets and equity by $45 million. So, the new market value balance sheet after the stock issue will be:

Market value balance sheet |
| Cash | $ 45,000,000 |   | | |
  | Old assets | 582,000,000 |   | | |
  | NPV of project | 12,391,304 |   | Equity | $639,391,304 |
  | Total assets | $639,391,304 |   | Debt & Equity | $639,391,304 |

The stock price will remain unchanged. To show this, Stephenson will now have:

Total shares outstanding = 12,000,000 + 908,492
Total shares outstanding = 12,908,492

So, the share price is:

Share price = $639,391,304 / 12,908,492
Share price = $49.53

d. The project will generate $11 million of additional annual pretax earnings forever. These earnings will be taxed at a rate of 40 percent. Therefore, after taxes, the project increases the annual earnings of the firm by $6.6 million. So, the aftertax present value of the earnings increase is:

PVProject = $6,600,000 / .115
PVProject = $612,391,304

So, the market value balance sheet of the company will be:

Market value balance sheet |
| Old assets | $582,000,000 |   | | |
  | PV of project | 57,391,304 |   | Equity | $639,391,304 |
  | Total assets | $639,391,304 |   | Debt & Equity | $639,391,304 |
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