Stephenson. The company purchases real estate, including land and buildings, and rents the property to tenants. The
Question:
Stephenson. The company purchases real estate, including land and buildings, and rents the property 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 Stephenson Real Estate, Robert was the founder and CEO of a failed alpaca farming operation. The resulting bankruptcy made him extremely averse to debt financing. As a result, the company is entirely equity financed, with 8.5 million shares outstanding. The shares currently trade at $44.50 per share. Stephenson is evaluating a plan to purchase a huge tract of land in south-eastern Queensland for $50 million. The land will subsequently be leased to tenant farmers. This purchase is expected to increase Stephenson's annual profit before tax by $11 million in perpetuity. Kim Weyand, the company's new CFO, has been put in charge of the project. Kim has determined that the company's current cost of capital is 12.5%. She feels that the company would 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 entirely. Based on some conversations with investment banks, she thinks that the company can borrow the required funds at 8%. From her analysis, she also believes that a capital structure in the range of 70% equity/30% debt would be optimal. If the company goes beyond 30% debt, its debt would carry a lower rating and a much higher interest rate because the possibility of financial distress and the associated costs would rise sharply. Stephenson has a 30% corporate tax rate. Questions: 1. If Stephenson wishes to maximise its total market value, would you recommend that it use debt or equity to finance the land purchase? Explain. 2. Construct Stephenson's market value statement of financial position before it announces the purchase. 3. Suppose Stephenson decides to issue equity to finance the purchase. a. What is the net present value of the project? b. Construct Stephenson's market value statement of financial position after it announces that the firm will finance the purchase using equity. What would be the new price per share of the firm's shares? How many shares will Stephenson need to issue to finance the purchase?