financial analysis with excel

1. 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. Since Stephenson is an all-equity firm with 9 million shares of common stock outstanding, worth $37.80 per share, the market value of the firm is:

Market value of equity = $37.80(9,000,000)

Market value of equity = $340,200,000

So, the market value balance sheet before the land purchase is:

3. a. As a result of the purchase, the firm’s pretax earnings will increase by $18.75 million per year in perpetuity. These earnings are taxed at a rate of 40 percent. Therefore, after taxes, the purchase increases the annual expected earnings of the firm by:

Earnings increase = $18,750,000(1 – .40)

Earnings increase = $11,250,000

Since Stephenson is an all-equity firm, the appropriate discount rate is the firm’s unlevered cost of equity, so the NPV of the purchase is:

NPV = –$95,000,000 + ($11,250,000 / .102)

NPV = $15,294,118

b. After the announcement, the value of Stephenson will increase by $15,294,118, the net present value of the purchase. Under the efficient-market hypothesis, the market value of the firm’s equity will immediately rise to reflect the NPV of the project. Therefore, the market value of Stephenson’s equity after the announcement will be:

Equity value = $340,200,000 + 15,294,118

Equity value = $355,494,118

Since the market value of the firm’s equity is $355,494,118 and the firm has 9 million shares of common stock outstanding, Stephenson’s stock price after the announcement will be:

New share price = $355,494,118 / 9,000,000

New share price = $39.50

Since Stephenson must raise $95 million to finance the purchase and the firm’s stock is worth $39.50 per share, Stephenson must issue:

Shares to issue = $95,000,000 / $39.50

Shares to issue = 2,405,103

c. Stephenson will receive $95 million in cash as a result of the equity issue. This will increase the firm’s assets and equity by $95 million. So, the new market value balance sheet after the stock issue will be:

The stock price will remain unchanged. To show this, Stephenson will now have:

Total shares outstanding = 9,000,000 + 2,405,103

Total shares outstanding = 11,405,103

So, the share price is:

Share price = $450,494,118 / 11,405,103

Share price = $39.50

d. The project will generate $18.75 million of additional annual pretax earnings forever. These earnings will be taxed at a rate of 40 percent. Therefore, after taxes, the project increases the annual earnings of the firm by $11.25 million. So, the aftertax present value of the earnings increase is:

PVProject = $11,250,000 / .102

PVProject = $110,294,118

So, the market value balance sheet of the company will be:

4. a. Modigliani-Miller Proposition I states that in a world with corporate taxes:

VL = VU + TCB

As was shown in Question 3, Stephenson will be worth $450,494,118 if it finances the purchase with equity. If it were to finance the initial outlay of the project with debt, the firm would have $95 million worth of 6 percent debt outstanding. So, the value of the company if it financed with debt is:

VL = $450,494,118 + .40($95,000,000)

VL = $488,494,118

b. After the announcement, the value of Stephenson will immediately rise by the present value of the project. Since the market value of the firm’s debt is $95 million and the value of the firm is $488,494,118 we can calculate the market value of Stephenson’s equity. Stephenson’s market-value balance sheet after the debt issue will be:

Since the market value of the Stephenson’s equity is $393,494,118 and the firm has 9 million shares of common stock outstanding, Stephenson’s stock price after the debt issue will be:

Stock price = $393,494,118 / 9,000,000

Stock price = $43.72

5. If Stephenson uses equity in order to finance the project, the firm’s stock price will remain at $39.50 per share. If the firm uses debt in order to finance the project, the firm’s stock price will rise to $43.72 per share. Therefore, debt financing maximizes the per share stock price of the firm’s equity.

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