Financing maximizes the stock per share of srecs equity

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Reference no: EM131560619

Stephensen Real Estate Company (SREC) was founded 25 years ago by the current CEO, Robert Stephensen. The company purchases real estate and rents the properties to tenants. The company has shown a profit every year for the past 18 years and the shareholders are satisfied with the company’s management. Prior to founding SREC, Robert was the founder and CEO of a failed alpaca farming operation. The resulting bankruptcy made him very averse to debt financing. As a result, the company is entirely equity financed with 11 million shares of common stock outstanding. The company’s stock trades at $48.50 per share. Stephensen is evaluating a plan to purchase a huge tract of land in the southeastern USA for $45 million. The land will be subsequently be leased to tenant farmers. The purchase will increase SREC’s annual pretax earnings by $10 million in perpetuity. Kim Weygand the company’s new CFO is in charge of this project. Kim has determined that the company’s current W ACC is 10.5 percent. She feels that the company will be more valuable if it included debt in its capital structure, so she is evaluating whether the company should issue debt to finance the project. Based on some conversations with investment banks, she thinks that the company issue bonds at par value with a coupon of 7 percent. She also believes that a capital structure in the range of 70 percent equity to 30 percent debt would be optimal. SREC has a 40 percent corporate tax rate (state and federal). A. If SREC wishes to maximize its total market value, would you recommend that it issues debt or equity to finance the land purchase? Explain. B. Construct SREC’s market value balance sheet before it announces the purchase of the land. C. Given SREC’s annual pretax earnings of $10 million in perpetuity and the firm’s WACC of 10.5%, what is the NPV of the land purchase? Construct the new balance sheet and find the resulting price per share due to the investment decision to purchase. D. If SREC uses equity to fund the $45 million cost of the purchase, how many shares will the firm issue? Construct the new balance sheet after SREC issues equity and receives the $45 million cash proceeds. Also, find the resulting price per share. E. If SREC issues debt of $45 million to finance the land purchase, what will be the value of firm based on Modigliani-Miller 1963 Proposition I; what is the price per share? F. Which method of financing maximizes the stock per share of SREC’s equity?

Reference no: EM131560619

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