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 $49
$53.80 per share, the market value of the firm is:
Market value of equity = $53.80(12,000,000)
3. a. As a result of the purchase, the firm’s pre-tax earnings will increase by $11.5 million per year in
perpetuity. These earnings are taxed at a rate of 21 percent. Therefore, after taxes, the purchase
increases the annual expected earnings of the firm by:
Earnings increase = $11,500,000(1 – .21)
Earnings increase = $9,085,000
b. After the announcement, the value of Stephenson will increase by $37,523,810, 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:
Equity value = $645,600,000 + 37,523,810
c. Stephenson will receive $49 million in cash as a result of the equity issue. This will increase the
firm’s assets and equity by $49 million. So, the new market value balance sheet after the stock
issue will be:
Market value balance sheet
Cash
$ 49,000,000
Old assets
645,600,000
NPV of project
37,523,810
Equity
$732,123,810
Total assets
Debt & Equity
Market value balance sheet
Old assets
NPV of project
Equity
Total assets
Debt & Equity
$683,123,810
d. The project will generate $11.5 million of additional annual pretax earnings forever. These
earnings will be taxed at a rate of 21 percent. Therefore, after taxes, the project increases the
annual earnings of the firm by $6.9 million. So, the aftertax present value of the earnings increase
is:
PVProject = $9,085,000/.105
PVProject = $86,523,810
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 $732,123,810 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 $49 million and the value of the firm is
$742,413,810, 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
$732,123,810
Debt
$ 49,000,000
Tax shield
Equity
Total assets
$742,413,810
Debt & Equity
5. If Stephenson uses equity to finance the project, the firm’s stock price will remain at $56.93 per share.
Market value balance sheet
Total assets
$732,123,810
Debt & Equity