Question #4 (25 points): Capital Structure and Financing Choices Sandpiper Real Estate Co. (SRE) is a family firm, and Bob Samuals is currently CEO. The company is quite large, and engages in real estate transactions at many levels. Mr. Samuals and prior family members in management have always maintained an all equity capital structure; they have been unusually concerned about bankruptcy risk, despite the fact that SRE has an excellent financial track record. The company currently has 16 shares of outstanding common stock, w/current price of $46.75. At this stock price, the current cost of equity is 10,5%. SRE is currently evaluating a project to develop an extremely large area of land, valued at $95m, with a plan to lease the land to tenant farmers. This model has been highly succesful for them in the past, and this land is unusually good for farming. The projection is that the project will provide $21.2m. in annual case flows -- in perpetuity -- for the firm. The firm must raise capital to finance the project. You have been assisting in valuing this project, and want to make a case to Mr. Samuals that the firm should consider using debt. After much analysis, and discussion wlyour investment bankers, you can support the following: (1) the firm is a good canddiate to go to the debt markets, as it would have the highest bond rating, (b) a target D/E structure in your industry of 30% debt and 70% equity makes sense for your firm, as this would allow you to keep the top bond rating, and (3) were you to issue debt you would need to offer a 7% annual coupone rate on the debt. The firm has a 21% tax rate. Anwer the following questions to build your case to present to Mr. Samuals. Ignore ST Assets & Liabilities. Fill in the values for a simple market value balance sheet, with NO DEBT and before the project is initiated. HINT: The asset value of the firm must equal the equity value 0 Pre-Project Market Value Balance Sheet: Debt Orginal Assets Equity Total Shareholder & Debtholder Total ASSETS Value Find the value of the new project to the firm, i.e., find the NPV. Show your calculation in the cell below. HINT: This is a very simple calculation. NPV: Continue to ignore ST Assets & Liabilities, other htan new Cash added from equity financing (assume no financing costs, so the firm keeps the entire $95m). . Fill in the values for a simple No DEBT balance sheet for the firm, including the value added from the project. With Project Market Value Balance Sheet: Cash raised 95,000,000 Original Assets Debt PV of Project Equity Total Shareholder & Debtholder Total ASSETS Value You know that the per share equity price before the project is added is $46.75. Based on the new Balance Sheet w/Project, find the value per share after the project is added before financing is considered (# shares still 16 m). Use this value to determine how many shares of new equity the firm must issue to finance the $95m investment Finally, determine the share price for all shares once new shares are issued (16m + # new shares). Calculations based on #shares @ 16 m. New firm value Original # shares 16,000,000 Share Value: Number Shared needed: Calculationswith (#shares @ 16 m + # new shares). New firm value 16,000,000 Original # shares # New shares req. TOTAL# Shares Share Value: Use Recall that: SRE will incur no bankruptcy costs if they add this amount of debt to their capital structure. Modigliani-Miller Proposition I to find the firm value w/debt financing for the entire $95m oultay (no new equity), and calculate the share price that would result Show your work here to find the values in shaded box below: New Firm Value: New Share Value: Explain -- briefly -- to Mr. Samuals your calculations and make your case to him that debt is a good source of financing in this instance. SUMMARY OF ANALYSIS: OPTIONAL EXTRA CREDIT to be added to exam score (5 points): You should find that adding this debt increases value. There is an obvious strategy related to adding addidtional debt that will add even more value. Can you identify this strategy? (NO CALCULATIONS NEEDED FOR THIS ONE !!) Explain your logic for the extra credit question here: Question #4 (25 points): Capital Structure and Financing Choices Sandpiper Real Estate Co. (SRE) is a family firm, and Bob Samuals is currently CEO. The company is quite large, and engages in real estate transactions at many levels. Mr. Samuals and prior family members in management have always maintained an all equity capital structure; they have been unusually concerned about bankruptcy risk, despite the fact that SRE has an excellent financial track record. The company currently has 16 shares of outstanding common stock, w/current price of $46.75. At this stock price, the current cost of equity is 10,5%. SRE is currently evaluating a project to develop an extremely large area of land, valued at $95m, with a plan to lease the land to tenant farmers. This model has been highly succesful for them in the past, and this land is unusually good for farming. The projection is that the project will provide $21.2m. in annual case flows -- in perpetuity -- for the firm. The firm must raise capital to finance the project. You have been assisting in valuing this project, and want to make a case to Mr. Samuals that the firm should consider using debt. After much analysis, and discussion wlyour investment bankers, you can support the following: (1) the firm is a good canddiate to go to the debt markets, as it would have the highest bond rating, (b) a target D/E structure in your industry of 30% debt and 70% equity makes sense for your firm, as this would allow you to keep the top bond rating, and (3) were you to issue debt you would need to offer a 7% annual coupone rate on the debt. The firm has a 21% tax rate. Anwer the following questions to build your case to present to Mr. Samuals. Question #4 (25 points): Capital Structure and Financing Choices Sandpiper Real Estate Co. (SRE) is a family firm, and Bob Samuals is currently CEO. The company is quite large, and engages in real estate transactions at many levels. Mr. Samuals and prior family members in management have always maintained an all equity capital structure; they have been unusually concerned about bankruptcy risk, despite the fact that SRE has an excellent financial track record. The company currently has 16 shares of outstanding common stock, w/current price of $46.75. At this stock price, the current cost of equity is 10,5%. SRE is currently evaluating a project to develop an extremely large area of land, valued at $95m, with a plan to lease the land to tenant farmers. This model has been highly succesful for them in the past, and this land is unusually good for farming. The projection is that the project will provide $21.2m. in annual case flows -- in perpetuity -- for the firm. The firm must raise capital to finance the project. You have been assisting in valuing this project, and want to make a case to Mr. Samuals that the firm should consider using debt. After much analysis, and discussion wlyour investment bankers, you can support the following: (1) the firm is a good canddiate to go to the debt markets, as it would have the highest bond rating, (b) a target D/E structure in your industry of 30% debt and 70% equity makes sense for your firm, as this would allow you to keep the top bond rating, and (3) were you to issue debt you would need to offer a 7% annual coupone rate on the debt. The firm has a 21% tax rate. Anwer the following questions to build your case to present to Mr. Samuals. Ignore ST Assets & Liabilities. Fill in the values for a simple market value balance sheet, with NO DEBT and before the project is initiated. HINT: The asset value of the firm must equal the equity value 0 Pre-Project Market Value Balance Sheet: Debt Orginal Assets Equity Total Shareholder & Debtholder Total ASSETS Value Find the value of the new project to the firm, i.e., find the NPV. Show your calculation in the cell below. HINT: This is a very simple calculation. NPV: Continue to ignore ST Assets & Liabilities, other htan new Cash added from equity financing (assume no financing costs, so the firm keeps the entire $95m). . Fill in the values for a simple No DEBT balance sheet for the firm, including the value added from the project. With Project Market Value Balance Sheet: Cash raised 95,000,000 Original Assets Debt PV of Project Equity Total Shareholder & Debtholder Total ASSETS Value You know that the per share equity price before the project is added is $46.75. Based on the new Balance Sheet w/Project, find the value per share after the project is added before financing is considered (# shares still 16 m). Use this value to determine how many shares of new equity the firm must issue to finance the $95m investment Finally, determine the share price for all shares once new shares are issued (16m + # new shares). Calculations based on #shares @ 16 m. New firm value Original # shares 16,000,000 Share Value: Number Shared needed: Calculationswith (#shares @ 16 m + # new shares). New firm value 16,000,000 Original # shares # New shares req. TOTAL# Shares Share Value: Use Recall that: SRE will incur no bankruptcy costs if they add this amount of debt to their capital structure. Modigliani-Miller Proposition I to find the firm value w/debt financing for the entire $95m oultay (no new equity), and calculate the share price that would result Show your work here to find the values in shaded box below: New Firm Value: New Share Value: Explain -- briefly -- to Mr. Samuals your calculations and make your case to him that debt is a good source of financing in this instance. SUMMARY OF ANALYSIS: OPTIONAL EXTRA CREDIT to be added to exam score (5 points): You should find that adding this debt increases value. There is an obvious strategy related to adding addidtional debt that will add even more value. Can you identify this strategy? (NO CALCULATIONS NEEDED FOR THIS ONE !!) Explain your logic for the extra credit question here: Question #4 (25 points): Capital Structure and Financing Choices Sandpiper Real Estate Co. (SRE) is a family firm, and Bob Samuals is currently CEO. The company is quite large, and engages in real estate transactions at many levels. Mr. Samuals and prior family members in management have always maintained an all equity capital structure; they have been unusually concerned about bankruptcy risk, despite the fact that SRE has an excellent financial track record. The company currently has 16 shares of outstanding common stock, w/current price of $46.75. At this stock price, the current cost of equity is 10,5%. SRE is currently evaluating a project to develop an extremely large area of land, valued at $95m, with a plan to lease the land to tenant farmers. This model has been highly succesful for them in the past, and this land is unusually good for farming. The projection is that the project will provide $21.2m. in annual case flows -- in perpetuity -- for the firm. The firm must raise capital to finance the project. You have been assisting in valuing this project, and want to make a case to Mr. Samuals that the firm should consider using debt. After much analysis, and discussion wlyour investment bankers, you can support the following: (1) the firm is a good canddiate to go to the debt markets, as it would have the highest bond rating, (b) a target D/E structure in your industry of 30% debt and 70% equity makes sense for your firm, as this would allow you to keep the top bond rating, and (3) were you to issue debt you would need to offer a 7% annual coupone rate on the debt. The firm has a 21% tax rate. Anwer the following questions to build your case to present to Mr. Samuals