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So The Net Present Value of The Project $7,600,000.00

1. Stephenson should issue debt rather than equity to finance the $50 million land purchase. Debt financing provides a tax shield that increases the firm's value, while equity financing decreases value by diluting ownership. 2. Issuing equity to finance the purchase results in a net present value of $7.6 million for the project and increases the stock price to $43.34 per share. 3. If the purchase is financed with debt instead, the firm's value would be $460.1 million, with the stock price at $45.57 per share. Debt financing provides a higher per-share value than equity financing.

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55 views4 pages

So The Net Present Value of The Project $7,600,000.00

1. Stephenson should issue debt rather than equity to finance the $50 million land purchase. Debt financing provides a tax shield that increases the firm's value, while equity financing decreases value by diluting ownership. 2. Issuing equity to finance the purchase results in a net present value of $7.6 million for the project and increases the stock price to $43.34 per share. 3. If the purchase is financed with debt instead, the firm's value would be $460.1 million, with the stock price at $45.57 per share. Debt financing provides a higher per-share value than equity financing.

Uploaded by

Thasya Ivonne Haldis
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We take content rights seriously. If you suspect this is your content, claim it here.
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1.

If Stephenson wishes to maximize its total market value, he should issue debt to raise the
required finance to purchase the land worth $50 million. This is because debt financing can be
advantageous to the company in the form of tax shield as the interest payments made on the
debt amount are tax-deductible due to which the firm's taxable income gets reduced to the extent
of that amount, and hence including debt in the capital structure will benefit the company, by an
increase in the overall value of the firm.
On the other hand, if Stephenson goes for equity financing, the value of the firm will decrease as
the ownership and the earnings of the company get shared among each equity holder to the
extent of the share value held by him/her (thus lowering the value of the firm).

2.
Stephenson's market value balance sheet before it announces the purchase is:

Market value of
$382,500,000.00 =9,000,000*$42.5
equity

Market value balance


sheet
Particulars Amount Particulars Amount
Assets $382,500,000.00 Equity $382,500,000.00
Total
$382,500,000.00 Debt and equity $382,500,000.00
assets
(9 million shares of common stock outstanding * $42.50 per share.)

3.
a. The net present value of the project, when Stephenson decides to issue equity to finance the
purchase

Particulars Amount ($) Calculation


$50,000,000.0
Cash outlay
0
$12,000,000.0
Annual pretax income
0
EAT (Earnings after tax) $7,200,000.00 =12000000*(1-0.4)
$57,600,000.0
Present value =7200000/(12.5%)
0
Net present value $7,600,000.00 =-50000000+57600000
So the net present value of the project = $7,600,000.00

b. Stephenson's market value balance sheet after it announces that the firm will finance the
purchase using equity:
Stephenson Real Estate
Balance Sheet
(On announcement of equity issue to
new project)
Particualrs Amount ($) Particualrs Amount ($)
Asset (initial) $382,500,000.00 Equity $390,100,000.00
(=9,000,000*$42.50
)
NPV of plant $7,600,000.00
Total asset $390,100,000.00 $390,100,000.00

" The new price per share of the firm's stock"

New price per


$43.34 per share
share
(=$390,100,000/9,000,000 shares)

"The number of shares Stephenson would need to issue to finance the purchase"

Number of equity shares required to be issued to finance 1,153,668.67 = 1,153,669


the land purchase shares
(=$50,000,000/$43.34)
c. Stephenson's market value balance sheet after the equity issue but before the purchase has
been made

Stephenson Real Estate


Balance Sheet
(After the equity issue but before the
purchase)
Particualrs Amount ($) Particualrs Amount ($)
Land $50,000,000.00
Asset (initial) $382,500,000.00 Equity $440,100,000.00
(=9,000,000*$42.50
)
NPV of plant $7,600,000.00
Total asset $440,100,000.00 $440,100,000.00
Number of shares of common stock does Stephenson have outstanding and the price per share
of the firm's stock

NPV of the project $7,600,000.00


Share price (per share) =$390,100,000/9,000,000 shares $43.34
Number of shares =$50,000,000/$43.34 1,153,669
Total shares outstanding =9,000,000+1,153,669 10,153,669
Equity =390,100,000+50,000,000 $440,100,000.00

d. Stephenson's market value balance sheet after the purchase has been made

Stephenson Real Estate


Balance Sheet
(after the purchase has been made)
Particulars Amount ($) Particulars Amount ($)
Asset (initial) $382,500,000.00 Equity $440,100,000.00
(=9,000,000*$42.50
)
PV of project $57,600,000.00
Total asset $440,100,000.00 $440,100,000.00

4.
a. As per the Modigliani-Miller Proposition (M&M) with corporate taxes:

VL=VU+tcBVL=VU+tcB
where,

VL=PV of the levered firmVL=PV of the levered firm


VU=PV of unlevered firmVU=PV of unlevered firm
tc=corporate tax ratetc=corporate tax rate
B = Amount of debt

So,

VL=$440,100,000.00+0.40(50,000,000)VL=$440,100,000.00+0.40(50,000,000)
= $440,100,000.00 + $20,000,000
= $460,100,000
So the market value of the Stephenson company be if the purchase is financed with debt:

VL=$460,100,000VL=$460,100,000
b. Stephenson's market value balance sheet after both the debt issue and the land purchase

Market value balance


sheet
Unlevered
$440,100,000.00 Debt $50,000,000.00
value
Tax shield $20,000,000.00 Equity $410,100,000.00
Total assets $460,100,000.00 Debt & Equity $460,100,000.00

"The price per share of the firm's stock"

Stock Price Value of equity/Number of shares outstanding


Stock
$45.57
Price
=410,100,000/9,000,000

5.
Debt capital:

Stock
Value of equity/Number of shares outstanding
Price
Stock
$45.57
Price
=410,100,000/9,000,000

Equity capital:

Value of equtiy/Number of shares


New share price
outstanding
Share price (per
=$390,100,000/9,000,000 shares $43.34
share)

As per the above table, Stephenson should go for debt financing as the per-share value of
the debt financing is $45.57 whereas the per-share value of the equity financing is $43.34.

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