Corporate Finance Case Study

Stephenson Real Estate Recapitalization

GROUP MEMBERS

Do Habiba

G1015288


  

Hasan Ali Assegaff
Yolanda Iselinni Zainal Abidin

G1033871
G1028116 G1039829

Zulfikri Arif Umaiya

G1029799

. Stephenson is planning to purchase a huge track of land in southeastern United State for $95 million. The firm’s unlevered cost of equity capital (re) is 12. Stephenson is subject to a corporate tax rate of 40%. increasing Stephenson’s annual expected pre-tax earnings by $23 million in perpetuity. The land will subsequently be leased to tenant farmers.5%.Stephenson Company Stephenson Real Estate Company is an all-equity firm with 15 million shares of common stock outstanding worth $34.50 per share. The interest rate on Stephenson’s bonds is 8% per annum.

Based on the CFO analysis. . If the company goes beyond 30% debt. its bonds would carry a lower rating and a much higher coupon because the possibility of financial distress and the associated cost would rise sharply. she believes that a capital structure in the range of 70% equity / 30% debt would be optimal.

.Q1 If Stephenson wishes to maximize its total market value. would you recommend that it issue debt or equity in order to finance the land purchase? Explain.

Answer for Q 1  If Stephenson wishes to maximize the overall value of the firm. creating a tax shield that will increase the overall value of the firm. it should use debt to finance the $95 million purchase. Since interest payments are tax deductible. debt in the firm’s capital structure will decrease the firm’s taxable income. .

Q2 Construct Stephenson’s market-value balance sheet before it announces the purchase. .

Answer for Q 2 Since Stephenson is an all-equity firm with 15 million shares of common stock outstanding.50(15.000 So.500. worth $34.000 $517.500.500.000) Market value of equity = $517.000. the market value balance sheet before the land purchase is: Assets Total assets $517.000 Debt Equity Debt &Equity $517.500. the market value of the firm is: Market value of equity = $34.500.000 .000 $517.50 per share.

Construct Stephenson’s market-value balance sheet after it announces that the firm will finance the purchase using equity. a. 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.Q3 Suppose Stephenson decides to issue equity in order to finance the purchase. Construct Stephenson’s market-value balance sheet after the equity issue but before the purchase has been made. What is the net present value of the project? b. Construct Stephenson’s market-value balance sheet after 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? d. .

000 / .000. Therefore.800. the firm’s pre-tax earnings will increase by $23 million per year in perpetuity.40) Earnings increase = $13. so the NPV of the purchase is: NPV= –$95.000 Since Stephenson is an all-equity firm.400. the purchase increases the annual expected earnings of the firm by: Earnings increase = $23.800. These earnings are taxed at a rate of 40 percent. the appropriate discount rate is the firm’s unlevered cost of equity.125) NPV = $15.Answer for Q 3a As a result of the purchase.000 + ($13.000(1 – .000.000 . after taxes.

900.000 Total assets $532.900. Stephenson must issue: Shares to issue = $95.Answer for Q 3b After the announcement.4 million.797 .900.400.000.53 Shares to issue = 2.900.400.000 Market value balance sheet Old Assets $517.900. the market value of the firm’s equity will immediately rise to reflect the NPV of the project.673.53 per share.000.500.000 and the firm has 15 million shares of common stock outstanding.000 Since the market value of the firm’s equity is $532. Stephenson’s stock price after the announcement will be: New share price = $532.500.000 New share price = $35.900.000 Debt Equity Debt &Equity $532.000 NPV of project $15. the net present value of the purchase.53 Since Stephenson must raise $95 million to finance the purchase and the firm’s stock is worth $35. the value of Stephenson will increase by $15.000 / 15.000 Equity value = $532.000 + $15. the market value of Stephenson’s equity after the announcement will be: Equity value = $517. Under the efficient-market hypothesis.000 $532.000 / $35. Therefore.

900.000 $627.900. the new market value balance sheet after the stock issue will be: Market value balance sheet Cash Old Assets NPV of project Total assets $95.000 + 2. So. To show this.Answer for Q 3c Stephenson will receive $95 million in cash as a result of the equity issue.000 $15.000 Debt Equity Debt &Equity $627.400.673.000 $517.000 $627.000.673.673.500.000 The stock price will remain unchanged. the share price is: Share price = $627.900.900. Stephenson will now have: Total shares outstanding = 15.53 .000.797 Total shares outstanding = 17.797 So.000 / 17. This will increase the firm’s assets and equity by $95 million.797 Share price = $35.

900.900.000.000 Debt Equity $627.000 .500.000 $15.Answer for Q 3d The market value balance sheet of the company will be: Old Assets Building NPV of project Total assets $517.000 Debt &Equity $627.000 $627.900.400.000 $95.

Q4 Suppose Stephenson decides to issue debt in order to finance the purchase. a. What is the price per share of the firm’s stock? . Construct Stephenson’s market-value balance sheet after both the debt issue and the land purchase. What will the market value of the Stephenson company be if the purchase is financed with debt? b.

Answer for Q 4a Modigliani-Miller states that in a world with corporate taxes: VL = VU+ tcB As was shown in Question 3.000 + . If it were to finance the initial outlay of the project with debt. the firm would have $95 million. Stephenson will be worth $627.000.9 million if it finances the purchase with equity. the value of the company if it financed with debt is: VL = $627.000) VL = $665.000 .40 ($95.900.900. So.

900.9 million.900.000.000 Stock price = $38.900.000 $665.900.000. we can calculate the market value of Stephenson’s equity.900.9 million and the firm has 15 million shares of common stock outstanding.Answer for Q 4b After the announcement. the value of Stephenson will immediately rise by the present value of the project.06 .000 Debt Equity Debt &Equity $95.000 / 15. Stephenson’s stock price after the debt issue will be: Stock price = $570. Stephenson’s market-value balance sheet after the debt issue will be Value unlevered Tax Shield Total assets $627. Since the market value of the firm’s debt is $95 million and the value of the firm is $627.000 $665.000 $570.000 Since the market value of the Stephenson’s equity is $570.000.000 $38.

Q5 Which method of financing maximizes the per share stock price of Stephenson’s equity? .

53 per share.06 per share. Therefore.Answer for Q 5 If Stephenson uses equity in order to finance the project. debt financing maximizes the per share stock price of a firm’s equity. the firm’s stock price will rise to $38. the firm’s stock price will remain at $35. If the firm uses debt in order to finance the project. .

Conclusion • Stephenson should use debt to finance the purchase because it will maximize the company value and share price • The new capital structure after debt is used is 14% : 86% (debt : equity) • It is still well below the limit of 30% debt where afterwards the debt will be riskier .

THANK YU .

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