Stephenson Real Estate Recapitalization.

I need help creating a thesis and an outline on Stephenson Real Estate Recapitalization. Prepare this assignment according to the guidelines found in the APA Style Guide. An abstract is required. 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 maximize its total market value, it should use debt to finance the $110 million purchase. As interest payments are tax-deductible, Taxable income will decrease with debt in the capital structure, creating a tax shield to increase the overall value of the firm.

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Market value of equity =&nbsp.$35.20(15,000,000) =&nbsp.$528,000,000

Market value balance sheet

Assets $528,000,000&nbsp. Equity&nbsp. $528,000,000

Total&nbsp.assets $528,000,000&nbsp. Debt&nbsp.&&nbsp.Equity &nbsp.$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?

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.

Equity value = $507,500,000

Market value balance sheet

Old assets

$528,000,000

&nbsp.

&nbsp.

NPV of project

19,600,000

&nbsp.

Equity

$507,500,000

&nbsp.

Total assets

$547,600,000

&nbsp.

Debt & Equity

$547,600,000

Now,

The 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

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

&nbsp.

&nbsp.

Old assets

528,000,000

&nbsp.

&nbsp.

NPV of project

19,600,000

&nbsp.

Equity

$657,600,000

&nbsp.

Total assets

$657,600,000

&nbsp.

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

$528,000,000

&nbsp.

&nbsp.

PV of project

129,600,000

&nbsp.

Equity

$648,000,000

&nbsp.

Total assets

$657,600,000

&nbsp.

Debt & Equity

$657,600,000

4. a. 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

$657,600,000

&nbsp.

Debt

$110,000,000

&nbsp.

Tax shield

44,000,000

&nbsp.

Equity

591,600,000

&nbsp.

Total assets

$701,600,000

&nbsp.

Debt & Equity

$701,600,000

Stock price = $591,600,000 / 15,000,000

Stock price = $39.44

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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