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Eric Heisse, Meihan Chen, Daniel McDonald, Anthony Ramos
Stephenson Real Estate
7/31/18
Prof. Rajewski
Page 572
1. When Stephenson wishes to maximize its total market value, he should recapitalize. That is to say, a capital structure combining both equity and debt would be optimal.
First, recapitalization can optimize capital structure. The equity is the only component of the company’s capital at this moment. The single-component company will be less resilient when faced with a financial crisis. It is said Stephenson experienced bankruptcy before, so he actively resists debt. This response is not correct because it is the unreasonable rate of debt that causes the bankruptcy, not the debt itself. According to the new CFO Jennifer, she keeps the debt rate around 30 percent because excess debt will bring a lower rating and much higher coupon to the bonds since the possibility of financial distress and the relevant costs would rise dramatically. As a result, Stephenson Real Estate Company should issue its debt at a reasonable rate to make full use of its capital.
Second, recapitalization can make the economy more vital. As seen in the case, Stephenson Real Estate is now entirely equity financed. The investment it has is insufficient to make the new land purchase, which is projected to have a high rate of return. If Stephenson is conservative and refuses debt, by all means, he will lose an opportunity to make a more substantial fortune. Also, the new CFO points out the company’s now the capital cost is rather low, which means the capital has not been given full playoff. If changing into debt, the rest capital could attract more investment into this company, financing it to purchase the new land and in turn bring more profit. Thus, issuing debt drives its capital flow, creating more profit during the capital circulation.
Third, recapitalization tightens the bonds between companies. By issuing bonds, the relation between the debtor and the creditor becomes close. To order to guarantee its return, the creditor might push the debtor to optimize the latter’s business strategies, suggest its financial plan and so on. Thus the creditor turns into the outside force of the debtor’s development. With the supervision of the creditor, the real estate company might have a more all-rounded business blueprint, which could reduce the potential financial risk. Under the current trend of globalization, the recapitalization becomes more and more a necessity.
2. With 9 million shares of common stock outstanding, and the stock currently trades at $37.80 per share. The total Market value of equity is 9,000,000*$37.80 equal to $340,200,000 Because of Assets equal to Liabilities plus Stockholders’ Equity, total assets equal to total debt and Stockholders equity. Total assets and total debt and Stockholders equity are all $340,200,000.
Stephenson’s market value balance sheet:
Assets
Amount
Total Debt & Stockholders Equity
Amount
Assets
$340,200,000
Common Equity
$340,200,000
Total Assets
$340,200,000
Total Liabilities
$340,200,000
#3 A)
The NPV for Stephenson Real Estate is $15,294,117.65 (-95,000,000+18,750,000*(1-.40)/.102)
B) Balance Sheet
Assets
340,200,000
Debt
0
NPV Project
15,294,117.65
Equity (9,000,000*37.80+NPV
355,494,117,65
Total Assets
$355,494,117.65
Total Debt and Stockholder Equity
$355,494,117.65
Stock price after announcement= $39.50 (355,494,117.65/9,000,000)
Number of Shares= 2,405,063 (95,000,000/39.50)
C). Balance Sheet
Assets
340,200,000
Debt
0
Cash
95,000,000
Equity
450,494,117.65
NPV Project
14,294,117.65
Total Assets
$450,491,117.65
Total Debt and Shareholder Equity
$450,494,117.65
Total number of outstanding shares after issue= 11,405,063 (9,000,000+2,405,063)
D) Balance Sheet
Assets
340,200,000
Debt
0
PV Project
110,294,117.65
Equity
450,494,117.65
Total Assets
$450,494,117,65
Total Debt and Stockholders Equity
$450,494,117.65
Present Value= $110,295,117.65 (18,750,000*(1-.4)/.102
4.
A) Market Value of Stephenson company if purchased finance with debt
Vl = Vu + Tc * D
Present Value of Levered Firm = Vl
Present Value of Unlevered Firm = Vu
Corporate Tax Rate = Tc
Amount of Debt = D
Vl = $450,494,117.65 + 0.40 * $95,000,000
Vl = $450,494,117.65 + $38,000,000
Vl = $488,494,117.65
The Market Value of the Stephenson company is $488,494,117.65 if the purchased is financed with debt.
B) Market Value Balance Sheet
Unlevered Value of Stephenson
$450,494,117.65
Debt
$95,000,000.00
Tax Shield
$38,000,000.00
Equity
$393,494,117.65
Total Assets
$488,494,117.65
Total Debt & Stockholders Equity
$488,494,117.65
Stock Price = $393,494,117.65 / 9,000,000 outstanding shares
Stock Price = $43.72
5. To maximize the company’s stock price, instead of using equity to finance the purchase of new land, they can use debt. This would increase their stock price, leading to debt financing, maximizing their share price.
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