Stephenson Real Estate Company Case Study

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Stephenson Real Estate Company Case

Stephenson Real Estate Company is an all-equity firm with 15 million shares of common stock outstanding worth $32.50 per share. Stephenson is planning to purchase a huge track of land in southeastern Texas for $100 million. The land will subsequently be leased to tenant farmers, increasing Stephenson’s annual expected pre-tax earnings by $25 million in perpetuity. The firm’s unlevered cost of equity capital (r0) is 12.5%. Stephenson is subject to a corporate tax rate of 40%. The interest rate on Stephenson’s bonds is 8% per annum.

  1. a. If Stephenson wishes to maximize its total market value, would you recommend that it issue debt or equity in order to finance the purchase? Explain.
  2. Construct Stephenson’s market-value balance sheet before it announces the purchase.
  3. Suppose Stephenson decides to issue equity in order to finance the purchase.
  4. What is the net present value of the project?
  5. Construct Stephenson’s market-value balance sheet after it announces that the firm will finance the purchase using equity. What is the new price per share of the firm’s stock? How many shares will Stephenson need to issue in order to finance the purchase?

iii.   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?

  1. Construct Stephenson’s market-value balance sheet after the purchase has been made.
  2. Suppose Stephenson decides to issue debt in order to finance the purchase.
  3. What will the market value of Stephenson be if the purchase is financed with debt?
  4. 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’s stock?
  5. Which method of financing maximizes the per share stock price of Stephenson’s equity?
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