CHAPTER 16
STEPHENSON REAL ESTATE
RECAPITALIZATION
1. If Stephenson wishes to maximize the overall value of the firm, it should use debt to finance the $95
2. Since Stephenson is an all-equity firm with 9 million shares of common stock outstanding, worth
So, the market value balance sheet before the land purchase is:
Market value balance sheet
3. a. As a result of the purchase, the firm’s pretax earnings will increase by $18.75 million per year
Since Stephenson is an all-equity firm, the appropriate discount rate is the firm’s unlevered cost
of equity, so the NPV of the purchase is:
CHAPTER 16 C-2
b. After the announcement, the value of Stephenson will increase by $15,294,118, the net present
value of the purchase. Under the efficient-market hypothesis, the market value of the firm’s
equity will immediately rise to reflect the NPV of the project. Therefore, the market value of
Stephenson’s equity after the announcement will be:
Market value balance sheet
Old assets $340,200,000
Since the market value of the firm’s equity is $355,494,118 and the firm has 9 million shares of
common stock outstanding, Stephenson’s stock price after the announcement will be:
Since Stephenson must raise $95 million to finance the purchase and the firm’s stock is worth
$39.50 per share, Stephenson must issue:
c. Stephenson will receive $95 million in cash as a result of the equity issue. This will increase the
firm’s assets and equity by $95 million. So, the new market value balance sheet after the stock
issue will be:
Market Value Balance Sheet
Cash $95,000,000
The stock price will remain unchanged. To show this, Stephenson will now have:
So, the share price is:
CHAPTER 16 C-3
d. The project will generate $18.75 million of additional annual pretax earnings forever. These
So, the market value balance sheet of the company will be:
Market Value Balance Sheet
Old assets $340,200,000
4. a. Modigliani-Miller Proposition I states that in a world with corporate taxes:
VL = VU + TCB
As was shown in Question 3, Stephenson will be worth $450,494,118 if it finances the purchase
with equity. If it were to finance the initial outlay of the project with debt, the firm would have
b. After the announcement, the value of Stephenson will immediately rise by the present value of
the project. Since the market value of the firm’s debt is $95 million and the value of the firm is
$488,494,118 we can calculate the market value of Stephenson’s equity. Stephenson’s market-
value balance sheet after the debt issue will be:
Market Value Balance Sheet
Value unlevered $450,494,118 Debt $ 95,000,000
Since the market value of the Stephenson’s equity is $393,494,118 and the firm has 9 million
shares of common stock outstanding, Stephenson’s stock price after the debt issue will be:
5. If Stephenson uses equity in order to finance the project, the firm’s stock price will remain at $39.50
