Case Study Essay
Chapter 14 Closing Case
Professor: Darrell Early
October 8, 2011
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.
If Stephenson wishes to maximize 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, creating a tax shield that will increase the overall value of the firm. 2. Construct Stephenson’s market value balance sheet before it announces the purchase.
Since Stephenson is an all-equity firm with 15 million shares of common stock outstanding, …show more content…
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 Stephenson’s market value balance sheet after the purchase has been made.
The market value balance sheet of the company:
Old assets $517,500,000 Debt
Building $95,000,000 Equity $627,900,000
NVP of project $15,400,000
Total assets $627,900,000 Debt& Equity$627,900,000 4. Suppose Stephenson decides to issue debt in order to finance the purchase. a. 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 question 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 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 announcement, 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