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Stephenson Real Estate Company was founded 2 5 years ago by the current CEO, Robert Stephenson Real Estate Company was founded 2 5 years ago

Stephenson Real Estate Company was founded 25 years ago by the current CEO, Robert 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 8.7 million shares of common stock outstanding. The stock currently
trades at $46.50 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 12.5 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:
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 8.7 million shares of common stock outstanding. The stock currently
trades at $46.50 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 12.5 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).
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