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 $12$ million shares of common stock outstanding. The stock

currently trades at $$53\mathrm{.}80$ per share.

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

for $$49$ million. The land will subsequently be leased to tenant farmers. This purchase is

expected to increase Stephenson's annual pretax earnings by $$11\mathrm{.}5$ 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 $10\mathrm{.}5$ 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 $7$ percent. Based on 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 will 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$).$

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

debt or equity to finance the land purchase? Explain. $(2$ Marks$)$

Construct Stephenson's market value balance sheet before it announces the purchase. $(5$

Marks$)$

Suppose Stephenson decides to issue equity to finance the purchase.

i$.$ What is the net present value of the project? $(5$ Marks$)$

ii$.$ Construct Stephenson's market value balance sheet after it announces that the firm

will finance the purchase using equity. What would be the new price per share of the

firm's stock? How many shares will Stephenson need to issue to finance the purchase?

$(5$ Marks$)$

iii. Construct Stephenson's market value balance sheet after the equity issue but before

the purchase has been made. How many shares of common stock does Stephenson

have outstanding? What is the price per share of the firm's stock? $(5$ Marks$)$

iv$.$ Construct Stephenson's market value balance sheet after the purchase has been

made. $(5$ Marks$)$

Suppose Stephenson decides to issue debt to finance the purchase.

i$.$ What will the market value of Stephenson be if the purchase is financed with debt? $(5$

Marks$)$

ii$.$ Construct Stephenson's market value balance sheet after both the debt issue and the

land purchase. What is the price per share of the firm's stock? $(5$ marks$)$

Which method of financing maximizes the per$-$share stock price of Stephenson's equity? $(3$

Marks$)$