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lOMoARcPSD|4314341 Stephenson Real estate recapitalization Introdução às Neurociências (Universidade de Évora) StuDocu

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Stephenson Real estate recapitalization Introdução às Neurociências (Universidade de Évora)

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Stephenson Real Estate Recapitalization Chapter 14 Closing case

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Stephenson Real Estate Recapitalization 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 To maximise its total market value, it should use debt to finance the $110 million purchase. As interest payments are tax deductable, Taxable income will decrease with debt in the capital structure, creating a tax shield to increase the overall value of the firm. 2. Construct Stephenson’s market value balance sheet before it announces the purchase. Market value of equity = $35.20(15,000,000) = $528,000,000 Market value balance sheet Assets

$528,000,000

Equity

$528,000,000

Total assets

$528,000,000

Debt & Equity

$528,000,000

3. Suppose Stephenson decides to issue equity to finance the purchase. a. What is the net present value of the project? b. Construct Stephenson’s market value balance sheet after it announces that the firm will finance the purchase using equity. What would be the new price per share of the firm’s stock? How many shares will Stephenson need to issue in order to finance the purchase? c. Construct Stephenson’s market value balance sheet after the equity issue, but before the purchase has been made. How many shares of common stock does Stephenson have outstanding? What is the price per share of the firm’s stock?

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3 d. Construct Stephenson’s market value balance sheet after the purchase has been made. a. Earnings increase = $27,000,000(1 – .40) = $16,200,000 As Stevenson is an all-equity based firm, At firm’s unlevered cost of equity, the NPV of the purchase is = –$110,000,000 + ($16,200,000 / .125) = $19,600,000 b. After Stephenson announces that the firm will finance the purchase using equity, the value of Stephenson will increase by $20 million, the NPV of purchase. According to efficient market hypothesis, the market value of Stephenson’s equity will rise to reflect the NPV of the project.Hence, the market value of Stephenson’s equity after the announcement will be: Equity value = $528,000,000 + 19,600,000 Equity value = $507,500,000 Market value balance sheet Old assets

$528,000,000

NPV of project Total assets

19,600,000 $547,600,000

Equity

$507,500,000

Debt & Equity

$547,600,000

Now, Market value of the firm’s equity is $547,600,000 Shares of common stock outstanding=15 million New share price = $547,600,000 / 15,000,000 New share price = $36.51 Since, Stephenson has to raise $110 million to finance the purchase, it should issue: Shares to issue = $110,000,000 / $36. = 3,013,148

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4 c.

Stephenson will receive $110 million in cash as a result of the equity issue. This will increase the firm’s assets and equity by $110 million. So, the new market value balance sheet after the stock issue will be:

Market value balance sheet Cash

$110,000,000

Old assets

528,000,000

NPV of project

19,600,000

Total assets

$657,600,000

Equity

$657,600,000

Debt & Equity

$657,600,000

Total shares outstanding = 15,000,000 + 3,031,148 Total shares outstanding = 18,013,148 So, the share price is: Share price = $657,600 / 18,013,148 Share price = $36.51 d. After taxes, the project increases the annual earnings of the firm by $16.2 million. PVProject = $16,200,000 / .125= $129,600,000

Market value balance sheet Old assets PV of project

$528,000,000 129,600,000

Equity

$648,000,000

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Total assets

4.

a.

$657,600,000

Debt & Equity

$657,600,000

Modigliani-Miller Proposition with respect to corporate taxes: VL = VU + tCB The value of the company if it financed with debt is: VL = $657,600,000 + .40($110,000,000) VL = $701,600,000

b. Market value balance sheet Value unlevered Tax shield

$657,600,000 44,000,000

Total assets

$701,600,000

Debt

$110,000,000

Equity Debt & Equity

591,600,000 $701,600,000

Stock price = $591,600,000 / 15,000,000 Stock price = $39.44 5. Which method of financing maximizes the per-share stock price of Stephenson’s

equity? If Stephenson uses equity to finance the project, Stock price= $36.51 If Stephenson uses debt to finance the project, Stock price = $39.44 Hence, debt financing is instrumental in increasing the stock price of Stephenson’s equity.

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