Stephenson Real Estate Recapitalization - Corporate Finance - Ch 14 - Financial Leverage and Capital Structure Policy

1. If Stephenson’s goal is to maximize the overall value of the firm, it should use debt to finance the $105 million purchase. Since interest payments are tax deductible, debt in the firm’s capital structure will lower the firm’s taxable income, creating a tax shield that will increase the overall value of the firm.

2. Assets 675,000,000 Equity 675,000,000

Total Assets 675,000,000 Equity 675,000,000

3.

a. $21,500,000 * (1-.4) = $12,900,000 increase in annual expected earnings after taxes

NPV = -105,000,000 + (12,900,000 / 0.105) = $17,857,143

b. Old Assets 675,000,000 Equity 692,857,143

NPV of Project 17,857,143

Total Assets 692,857,143 Equity 692,857,143

Price per share - $38.49

Shares needed – 105,000,000 / 38.49 = 2,727,982

c. Old Assets 675,000,000 Equity 797,857,143

NPV of Project 17,857,143

Proceeds from Issue 105,000,000 Equity

Total Assets 797,857,143 Total Equity 797,857,143

Price per share - $38.49

Shares outstanding – 797,857,143 / 38.49 = 20,728,946

d. Old Assets 675,000,000 Equity 797,857,143

PV of Land 122,857,143

Total Assets 797,857,143 Equity 797,857,143

4.

e. VL=VU+TC(B+ = 797,857,143 + .40*105,000,000 = 839,857,143

f. Debt Issue:

Old Assets 675,000,000 Equity 734,857,143

NPV of Project 59,857,143 Debt 105,000,000

Proceeds from Issue 105,000,000

Total Assets 839,857,143 Total Equity 839,857,143

Land Purchase:

Old Assets 675,000,000 Equity 734,857,143

PV of Project 164,857,143 Debt 105,000,000

Total Assets 839,857,143 Total Equity 839,857,143

Price per share – 734,857,143 / 18,000,000 = $40.83

5. To maximize the highest possible price per share, Stephenson should choose to finance the project with debt.