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Read the Closing Case entitled A Stephenson Real Estate Recapitalization (attached) and answer the five questions posed on this sheet. ,,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. ,,Stephenson should issue debt, since interest is tax deductible and so provides a tax shield which will increase the value of the firm ,,,2. Construct Stephenson’s market value balance sheet before it announces the purchase. ,,,,Market Value Balance Sheet, Assets , Equity , Total assets , Debt & Equity , ,,3. Suppose Stephenson decides to issue equity to finance the purchase.,, a. What is the net present value (NPV) of the project? (Hint: Calculate the after-tax increase in earnings as a result of the land purchase as a perpetuity.) ,,The after tax cash flows each year are 14 million X (1-0.4) = $8.4 million ,Since the cash flows are a perpetuity, the present value is calculated as Annual cash flow/discounting rate. As the firm is all equity financed, the discounting rate should be the cost of equity which is the current cost of capital which is 12.5%. ,PV of cash flows = 8.4/12.5% = $67.2 million ,The cost of project is 60 million ,NPV = 67.2 – 60 = $7.2 million ,Presently the market value of equity is 20 million shares X $33.50 = $670 million ,After the project the value of equity will increase to 670+7.2 = 677.2 million ,Given that there are 20 million shares, price per share will be 677.2/20 = $33.86 ,Number of shares to be issued = 60,000,000/33.86 = 1,772,002 ,, , , b. Construct Stephenson’s market value balance sheet after it announces the purchase , will be financed with equity. (Hint: The market value of equity increases by the , market value or NPV of the land purchase.) ,,Market Value Balance Sheet, Old assets , , NPV of project Equity , Total assets , Debt & 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 issue?,,, ,,, c. Construct Stephenson’s market value balance sheet after the equity issue, but , before the purchase has been made. ,, ,Market Value Balance Sheet, Cash , Old assets , NPV of project Equity , Total assets Debt & Equity ,,, How many shares of common stock does Stephenson have outstanding after the , new equity issue?, ,,,,, What is the price per share of the firm’s stock? ,,,,,, , , d. Construct Stephenson’s market value balance sheet after the purchase has been , made. ,,Market Value Balance Sheet, Old assets , PV of project Equity , Total assets Debt & Equity ,,, ,,,,,,,4. Suppose Stephenson decides to issue debt to finance the purchase. ,, a. What will the market value of the Stephenson company be if the purchase is , financed with debt? (Hint: VL = VU + tCB.),,,,, ,, b. Construct Stephenson’s market value balance sheet after both the debt issue and the land purchase. What is the price per share of the firm’s stock after the debt issue? ,,,Market Value Balance Sheet, Value unlevered Debt , Tax shield Equity , Total assets Debt & Equity ,,,,,,,,5. Which method of financing maximizes the per-share stock price of Stephenson’s equity? Explain.,

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