454 PART 7 Long-Term Financing CHAPTER CASE uppto leadidin tans words Stephenson Real Estate Recapitalization isiononFl bris azerboua Stephenson Real Estate Company was founded annual pretax earnings by $12 million in perpetuity. Kim 25 years ago by the current CEO, Robert Stephenson. Weyand, the company's new CFO, has been put in charge The company purchases real estate, including land and of the project. Kim has determined that the company's cur- buildings, and rents the property to tenants. The com- rent cost of capital is 12.5 percent. She feels that the com- pany has shown a profit every year for the past 18 years, pany would be more valuable if it included debt in its and the shareholders are satisfied with the company's capital structure, so she is evaluating whether the com- management. Prior to founding Stephenson Real Estate, pany should issue debt to entirely finance the project. Robert was the founder and CEO of a failed alpaca farm- Based on some conversations with investment banks, she ing operation. The resulting bankruptcy made him ex- thinks that the company can issue bonds at par value with tremely averse to debt financing. As a result, the a coupon rate of 8 percent. From her analysis, she also company is entirely equity financed, with 9 million believes that a capital structure in the e in the range of 70 percent shares of common stock outstanding. The stock cur- equity/30 percent debt would be optimal. If the company rently trades at $42.50 per share. goes beyond 30 percent debt, its bonds would carry a Stephenson is evaluating a plan to purchase a huge lower rating and a much higher coupon because the pos- tract of land in the southeastern United States for $50 mil- sibility of financial distress and the associated costs would lion. The land will subsequently be leased to tenant farm- rise sharply. Stephenson has a 40 percent corporate tax ers. This purchase is expected to increase Stephenson's rate (state and federal). QUESTIONS 1. If Stephenson wishes to maximize its total market shares of common stock does Stephenson value, would you recommend that it issue debt or have outstanding? What is the price per share equity to finance the land purchase? Explain. of the firm's stock? 2. Construct Stephenson's market value balance d. Construct Stephenson's market value bal- sheet before it announces the purchase ance sheet after the purchase has been 3. Suppose Stephenson decides to issue equity to made. finance the purchase. 4. a. What is the net present value of the project? Suppose Stephenson decides to issue debt to fi- b. nance the purchase. Construct Stephenson's market value bal- ance sheet after it announces that the firm a. What will the market value of the Stephenson will finance the purchase using equity. What Company be if the purchase is financed with would be the new price per share of the firm's debt? stock? How many shares will Stephenson b. Construct Stephenson's market value bal- need to issue to finance the purchase? ance sheet after both the debt issue and the C . Construct Stephenson's market value bal- land purchase. What is the price per share of ance sheet after the equity issue but before the firm's stock? the purchase has been made. How many 5. Which method of financing maximizes the per-share stock price of Stephenson's equity