Stephenson Real Estate Recapitalization Corporate Finance Assignment

1. Stephenson Real Estate
Recapitalization
Corporate Finance Case Study
Shahin Firouztash 1111200071
Jevgenijs Lesevs 1111200131
Khatereh Azarnoor 1101600315
Yoong Khai Hung 1111200139
Aliakbar Bahrpeyma1091200261
Uun Ainurrofiq 1111200141
Poon Wai Chuen 1111200122

2. Case Overview
Introduction (Shahin) Founded 25 years ago by current CEO, Robert Stephenson
Purchase real state, building and rents property to
tenants. Has shown profit for the last 18 years
The company has 20 million shares outstanding
Last traded price was USD 35.50 per share
STEPHENSON Real Estate
The company has virtually no debt
The current cost of capital of the company is 12.5%
The company is subject to 40% corporation tax rate

3. Case Overview
He was the founder and CEO
of a failed alpaca farming
operation. The resulting
bankruptcy made him
extremely averse to debt
financing!!!
Increases the earnings by
USD 14 million on pre-tax
basis
Robert, CEO
Planning for a Lease it for the
new project! tenant farmers
Purchase track of land in of
land in the southeastern
USA for USD 60 million

4. Case Overview
If 30% dept:
• much higher
Kim, The new CFO coupon rate
“I think it would be more valuable if we include debt in • bonds would carry a
company’s capital structure , so we should finance this lower rate
project using debt structure…” • financial distress
and associated
Based of my
costs
conversations with Based on my analysis
investment banks
Capital structure
We should issue of 70% of equity
bonds with 8% and 30% of debt is
coupon rate the most profitable
for the company

5. Question 1
If Setephenson wishes to maximize its total market
value, would you recommend that it issue debt or equity
to finance the land purchase? Explain.

6. Debt vs Equity Financing
60 million Land Purchase
Debt Equity
Maximize Stephenson Real Estate total
market value

7. Equity Financing
Advantages
 You can use your cash and that of your investors when
you start up (no large loan payments)
 If business fails you don’t need to return money to
investors.
 Investors may offer valuable business assistance that
you may not have.
Disadvantages
 investors own a piece of your business
 you are expected to act in investors best interests

8. Debt Financing
Advantages
 Allows you to have control of your own destiny
 The lender(s) from whom you borrow money do not
share in your profits
 You can apply for a loan that has more favorable terms.
 If you finance your business using debt, the interest you
repay on your loan is tax-deductible.
Disadvantages
 Large loan payments
 Credit rating can be spoiled

9. Question 1 Answer
Stephenson should use debt to finance the $60
million purchase!
1. interest payments are tax deductible
2. debt in capital structure will decrease the
firm’s taxable income
3. It creates a tax shield that will increase the
overall value of the firm.

10. Question 2
Construct Stephenson’s market value balance
sheet before it announces the purchase.

11. Question 2
Since Stephenson is an all-equity firm with 20 million shares of
common stock outstanding, worth $35.50 per share, the market
value of the firm is:
Market value of equity = $35.50 x 20,000,000
Market value of equity = $710,000,000

12. Question 3a & 3b
Suppose Stephenson decides to issue equity to
finance the purchase.
a. What is the net present value of the project?
b. Construct Stephenson’s market value balance sheet after it
announces that the firm will finance the purchase with equity. What
would be the new price per share of the firm’s stock? How many
shares will Stephenson need to issue?

13. NPV of the Project
 Initial Outlay = $60,000,000
 Annual pretax earnings = $14,000,000
 Earnings after tax = $14,000,000 x (1-0.40)
= $ 8,400,000
 NPV(project) = -$60,000,000 + ($8,400,000/0.125)
= $7,200,000

14. Upon Announcement of Equity Issue to New Project
Stephenson Real Estate
Balance Sheet
(Upon Announcement of Equity Issue to New Project)
Old Asset (20m x $35.50)= $710,000,000 Equity $717,200,000
NPV of plant $ 7,200,000
The Price is Risen to reflect
the news concerning the new
Total Asset $717,200,000 project
New Price per share= $717,200,000 / 20,000,000 shares = $35.86 per share
Number of shares to issue to finance the purchase = $60,000,000 / $35.86
= 1,673,173 shares

15. Question 3c & 3d
c. Construct Stephenson’s market value balance sheet
after the equity issue but before the purchase has
been made. How many shares of common stock does
Stephenson have outstanding? What is the price per
share of the firm’s stock?
d. Construct Stephenson’s market value balance sheet
after the purchase has been made !

16. Non-profitable project:
NPV of the project =$0
Share price = 710.000.000/20.000.000 = $35.5 per share
Number of shares = 60.000.000 / 35.5 = 1.690.140
Total number of share out standing = 21.690.140
Equity = 710.000.000 +60.000.000 = $770.000.000
Profitable project:
NPV of the project = $ 7.200.00
Share price = 717.200.000/20.000.000 = $35.86 per share
Number of shares = 60.000.000 / 38.86 = 1.673.173
Total number of share out standing = 21.673.173
Equity = 717.200.000 +60.000.000 = $777.200.000

17. Upon Issuance of Equity, before Purchase
Stephenson Real Estate
Balance Sheet
(Upon Issuance of Equity, before Purchase)
Cash = $ 60,000,000 Equity $777,200,000
Old Asset (20m x $35.50)= $710,000,000
NPV of plant $ 7,200,000
Total Asset $777,200,000

18. Upon Completion of Purchase
PV Project = $8,400,000 / .125
PV Project = $67,200,000
Stephenson Real Estate
Balance Sheet
(Upon Completion of Purchase)
Old Asset (20m x $35.50)= $710,000,000 Equity $777,200,000
PV of project $ 67,200,000
Total Asset $777,200,000

19. Question 4
Suppose Stephenson decides to issue debt to
finance the purchase.
a. What will the market value of the Stephenson company?
b. Construct Stephenson’s market value balance sheet after both the
debt issue and the land purchase. What is the price per share of
the firm stock?

20. Tax Shield
The reduction in income taxes that results from
taking an allowable deduction from taxable income
Exp of Non Taxable Income :
• debt interest
• mortgage interest,
• medical expenses,
• charitable donations,
• amortization
• and depreciation.

21. Capital Structure under Corporate Tax
Unlevered Firm Levered Firm
0% 0%
Debt Tax
Tax
Equity
Debt
Equity
The levered firm pay less taxes because debt interest is non
taxable income. Thus the sum of the debt + equity of levered
firm is greater than the unlevered (all equity) firm

22. Financing by Debt
Modigliani-Miller Proposition I
in a world with corporate taxes

23. Balance Sheet & Stock Price
Stock price = Value of Equity / Number of Shares Outstanding
Stock price = $741,200,000 / 20,000,000
Stock price = $37.06

24. Question 5
Which method of financing maximizes
the per-share stock price of
Stephenson’s equity?

25. Debt vs Equity

26. Equity Financing (review)
Advantages
 You can use your cash and that of your investors when
you start up (no large loan payments)
 If business fails you don’t need to return money to
investors.
 Investors may offer valuable business assistance that
you may not have.
Disadvantages
 investors own a piece of your business
 you are expected to act in investors best interests

27. Debt Financing (review)
Advantages
 Allows you to have control of your own destiny
 The lender(s) from whom you borrow money do not
share in your profits
 You can apply for a loan that has more favorable terms.
 If you finance your business using debt, the interest you
repay on your loan is tax-deductible.
Disadvantages
 Large loan payments
 Credit rating can be spoiled

28. Calculation on Price per Share
Equity Capital Debt Capital
New share price = Stock price =
$717,200,000 / 20,000,000 $741,200,000 / 20,000,000
New share price = $35.86 Stock price = $37.06

29. Thank You