$***$PLEASE SHOW WORK FOR EXCEL$***$

Stephenson Real Estate Company was founded $25$ years ago by the current CEO, Robert 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 $8\mathrm{.}7$ million shares of common stock outstanding. The stock currently

trades at $$46\mathrm{.}50$ per share.

Stephenson is evaluating a plan to purchase a huge tract of land in the southeastern United

States for $$65$ million. The land will subsequently be leased to tenant farmers. This purchase is

expected to increase Stephenson's annual pretax earnings by $$14$ 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 $12\mathrm{.}5$ percent. 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 entirely finance the project. Based on some conversations with

investment banks, she thinks that the company can issue bonds at par value with a coupon

rate of $8$ percent. From her analysis, she also believes that a capital structure in the range of

$70$ percent equity$/30$ percent debt would be optimal. If the company goes beyond $30$ percent

debt, its bonds would carry a lower rating and a much higher coupon because the possibility of

financial distress and the associated costs would rise sharply. Stephenson has a $21$ percent

corporate tax rate $($state and federal$).$

Input area:A $,$ B

If Stephenson wishes to maximize its total market value, would you recommend that it issue

debt or equity to finance the land purchase? Explain.

Assets

Total assets

a$)$ Perpetual aftertax earnings

NPV of purchase

b$)$

Old assets

NPV of project

Total assets

New share price

Shares to issue

c$)$

Cash

Old assets

NPV of project

Total assets

Total shares outstanding

Share price

d$)$ PV of earnings increase

Equity

Debt & Equity

Balance Sheet

$?$

Equity

Debt & Equity

Equity

Debt & Equity

Balance Sheet

Balance Sheet

Equity

Debt & Equity B C

D

F

G

a$)$ Value of levered company

Note ${?}^{(}()**)$:$TC=$ Tax rate

b$)$

Which method of financing maximizes the per share stock price of Stephenson's equity?