Case Study: Managerial Finance Chapter 14

BUS650 managerial Finance Chapter 14 Closing Case Professor Darrell Early October 8, 2011 1. If Stephenson wishes to maximize its total commercialise distinguish, would you recommend that it slue debt or honor to pay the prop up bargain for? Explain. If Stephenson wishes to maximize the boilers suit esteem of the level, it should use debt to pay the $95 one cardinal million grease ones palms. Since interest payments be tax deductible, debt in the firms capital structure leave behind decrease the firms taxable income, creating a tax shield that provide development the overall value of the firm. 2. defecate Stephensons merchandise value ratio public opinion poll before it announces the leverage.Since Stephenson is an all-equity firm with 15 million grants of common filiation outstanding, expenditure $34. 50 per share, the commercialise value of the firm is foodstuff value of equity = $34. 50(15,000,000) Market value of equity = $517,500,000 So, the market va lue balance tag before the land barter for is Assets $517,500,000 Debt - candour $517,500,000 get along assets $517,500,000 Debt &Equity $517,500,000 3. Suppose Stephenson decides to sleep with equity to finance the purchase. a. What is the network present value of the reckon? As a result of the purchase, the firms pre-tax earnings leave behind growth by$23 million per year in perpetuity.These earnings are taxed at a rate of40 percent. in that respectfore, afterward taxes, the purchase increases the annual judge earnings of the firm by Earnings increase = $23,000,000(1 . 40) Earnings increase = $13,800,000 Since Stephenson is an all-equity firm, the appropriate discount rate is the firms unlevered cost of equity, so the NPV of the purchase is NPV= $95,000,000 + ($13,800,000 / . 125)NPV = $15,400,000 b. Construct Stephensons market value balance shred after it announces that the firm will finance the purchase using equity.What would be the new price per share of the firm s line of work? How legion(predicate) shares will Stephenson need to issue in order to finance the purchase? After the announcement, the value of Stephenson will increase by $15. 4 million, the net present value of the purchase. Under the efficient-market hypothesis, the market value of the firms equity will immediately rise to reflect the NPV of the project. Therefore, the market value of Stephensons equity after the announcement will be Equity Value = $517,500,000 + $15,400,000 Equity Value = $ 532,900,000 Market value balance sheetOld assets $517,500,000Debt NVP of project$15,400,000Equity $532,900,000 Total equity$532,900,000Debt & Equity$532,900,000 Since the market value of the firms equity is $532,900. 000 and the firm has 15 million shares of common stock outstanding. Stephensons stock price after the announcement will be youthful share price $532,900,000/ $15,000,000 New share price $35. 53 Since Stephenson moldiness raise $95 million to finance the purchase and the firm s stock worth $35. 53 per share, Stephanie must issue Shares to issue = $95,000,000/$35. 53 Shares to issue = $2,673,797 c.Construct Stephensons market value balance sheet after the equity issue, but before the purchase has been made. How many shares of common stock does Stephenson have out- standing? What is the price per share of the firms stock? Stephenson will receive $95 million in cash as a result of the equity issue. This will increase the firms assets and equity by $95 million. So, the new market value balance sheet after the stock issue will be Market value balance sheet Cash$95,000,000Debt Old assets$517,500,000Equity$627,900,000 NPV of project$15,400,000 Total Assets$627,900,000Debt & Equity$627,900,000The stock change will remain unchanged. To show this Stephenson will have to Total shares outstanding = $15,000,000 + 2,673,797 Total shares outstanding = 17,673,797 So the share price is Share price = $627,900,00/$17,673,797 Share price = $35. 53 d. Construct Stephensons m arket value balance sheet after the purchase has been made. The market value balance sheet of the company Old assets $517,500,000Debt edifice $95,000,000Equity$627,900,000 NVP of project$15,400,000 Total assets $627,900,000Debt& Equity$627,900,000 4. Suppose Stephenson decides to issue debt in order to finance the purchase. . What will the market value of the Stephenson company be if the purchase is financed with debt? Modilgliani-Miller states that in a world with corporate taxes Vl = Vu + cB As was shown in interrogative mood 3, Stephenson will be worth $627. 9 million if it finances the purchase with equity. It is to finance the initial the outlay of the project with debt the firm would have $95 million. So the value of the company if it financed with debt is Vl = $627,900,000 + . 40 ($95,000,000) Vl = $665,900,000 b. Construct Stephensons market value balance sheet after both the debt issue and the land purchase.What is the price per share of the firms stock? After the announc ement, the value of Stephenson will immediately rise by the percent value of the project. Since the market value of the firms debt is $95 million and the value of the firm is $627. 9 million w can calculate the market value of Stephensons equity. Stephensons market value balance sheet after the debt issue will be Value unlevered$627,900,000Debt$95,000,000 Tax sheet$38,000,000Equity$570,900,000 Total assets $665,900,000Debt& Equity$665,900,000 Since the market value of Stephensons equity is $570. million and the firm has 15 million shares of common stock outstanding. Stephensons stock price after the debt issue will be Stock Price = $570,900,000/$15,000,000 Stock Price = $38. 06 5. Which regularity of financing maximizes the per-share stock price of Stephensons equity? If Stephenson uses equity in order to finance the project, the firms stock price will remain at 35. 53 per share. If the firm uses debt in order to finance the project, the firms stock price will rise to $38. 06 per s hare. There fare, debt financing maximizes the per share stock price of a firms equity.