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 companys 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 of common stock outstanding. The stock currently trades at $44.50 per share.

Stephenson is evaluating a plan to purchase a huge tract of land in the southeastern United States for $50 million. The land will subsequently be leased to tenant farmers. This purchase is expected to increase Stephensons annual pretax earnings by $11 million in perpetuity. Kim Weyand, the companys new CFO, has been put in charge of the project. Kim has determined that the companys 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).

Autobeve Om CumineCuplul 13 C. Sudy Tampa Baud Search Lam Huy Thi || FIG Home nsert Page Layout Formulas D Reviw View Share Comments trial - 10 AA Wrap Test Linked Cell 2 Neutral 4 Paste - Copy Format Paint Input 2 Normal 22 Heading 42 Conditional Format as Normal 2 Formatting - Tohle Autosum 27 0 Sort Find Filter Select Merge Center $ % Normal 3 Note 2 Insert Delete Format Idees Sensity Clpboard Font Allonnen kumber Styles Cels Eating deas Sensitivity 022 & F H K M N o P Q R S X Y 7 Input area 7 8 10 S S S 11 12 13 14 Shares outstanding Share price Purchase price of land Perpetual earnings increase Current cost of capital Cost of new debt Optimal equity weight Optimal debt weight Tax rate 8,500,000 44.50 50,000,000 11 000 000 12 50% 8% 70% % 30% 215 13 16 17 18 Output area: 19 20 21 23 23 2) Assets Total assets S S 378 250,000 378.250.000 Equity Debt & Equity $ $ 378,250.000 $ 378,250.000 25 25 27 3) a) Perpetual aftertax eamings $ 8890.000 NPV of purchase $ 19,520,000 29 30 b) S 31 32 Old assets NPV of project Total acts Balance Sheet 378 250 ODD 19 520 ODD 397.770,000 Equity S Dobl & Equity $ 397770 000 $ $ 397,770.000 34 35 35 37 New share price $ 46.80 Shares to issue 1,068,467 c) S S. Cash Old Assets Balance Sheet 50,000,000 378 250 000 Chapter 13 Case Study Rescue 00 100 Currect Chapter 13 CS.cy Templates - Esud Search Lam Huy Thi || Page Layout Formulas D Reviw View Help Share Comments Wrap Test General Linked Cell 2 Neutra Neutral Autobeve Om File Home nsert X Cut LL Paste Format Paint Clpboard 5 D22 Paris - 10 AA BLUE 4 Input 2 Normal 22 Heading 42 Conditional Format as Normal 2 Formatting - Tohle Autosum 27 0 Sort Find a Filter Select $ % Mege & Carter Normal 3 Note 2 does Insert Delete Format Sensity 0 Font Allonnen kumber Styles Cels Eating deas Sensitivity & c F F H K M N P Q R S X Y 7 Total assets S 397,770,000 Debt & Equity $ 397,770.000 34 35 New share price S s 46.80 30 3T Shares to issue 1,068,457 32 c) 60 S Balance Sheet 50,000,000 378.250,000 41 Cash Old assets NPV of project Total assets 19.520.000 Equity S $ $ $ 49 447,770.000 447,770,000 Dect & Equity 447,770,000 09 Total shares outstanding 9,568,457 49 Share price S 46.80 43 d) PV of earrings increase 2 7 Balance Sheet 378,250,000 51 52 53 54 Old assets PV of project Total assets S 2 2 ? Equity Det & Fouity 55 4) a) Value of lovered company LVL = VU+TC'D Note: TC = Tax rate 57 b) Balance Sheet 58 59 2 Value unlevered Taxshield value Total assets ? 2 Deht Equity Debt & Equity 2 ? 2 01 62 Stock share price ? 1 63 5) Which method of financing maximizes the per stare stock price of Slephenson's equily? Chapter 13 Case Study Rret 00 100