Homework answers / question archive / Stephenson Real Estate Recapitalization Stephenson Real Estate Company was founded 25 years ago by the current CEO, Robert Stephenson

Stephenson Real Estate Recapitalization Stephenson Real Estate Company was founded 25 years ago by the current CEO, Robert Stephenson

Business

Share With

Stephenson Real Estate Recapitalization 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 8.5 million shares of common stock outstanding. The stock currently trades at $44.50 per share. Stephenson is 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 Stephenson's annual pretax earnings by $11 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 capital 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). included debt in Input area: Nothing selected. Select an object or text to format. $ $ $ 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% 21% 315 words Output area: 1) If Stephenson wishes to maximize its total market value, would you recommend that it issue debt or equity to finance the land purchase? Explain. 12) Assets Total assets Equity Debt & Equity 3) a) Perpetual aftertax earnings NPV of purchase b) Balance Sheet ? Old assets NPV of project Total assets Equity Debt & Equity Nothing selected. Select an object or text to format. New share price Shares to issue c) Balance Sheet Cash Old assets NPV of project Total assets Equity Debt & Equity Total shares outstanding ? Share price d) PV of earnings increase Balance Sheet Old assets PV of project Total assets Equity 315 words 4) a) Value of levered company <--VL = VU+TC D Note*: TC = Tax rate