XYZ company is entirely equity financed, with 12 million shares of common stock outstanding. The stock currently trades at $48.50 per share. XYZ is evaluating a growth project which will cost $45 million. The project will bring in $11 million earnings (cash flows) per year in perpetuity. XYZ’s current cost of capital is 11.5 percent. The company could be more valuable if it included debt in its capital structure, so XYZ management is evaluating whether the company should issue debt to entirely finance the project. If the company uses debt, then the debt will carry a 7% interest expense. XYZ has a 40 percent corporate tax rate (state and federal). 1. If XYZ wishes to maximize its total market value, would you recommend that it issue debt or equity to finance the land purchase? Explain. 2. Construct XYZ’s market value balance sheet before it announces the purchase. 3. Suppose XYZ decides to issue equity to finance the purchase. a. What is the net present value of the project? b. Construct XYZ’s market value balance sheet after it announces that the firm will finance the purchase using equity. b1. What would be the new price per share of the firm’s stock? b2. How many shares will XYZ need to issue to finance the purchase? c. Construct XYZ’s market value balance sheet after the equity issue but before the purchase has been made. c1. How many shares of common stock does XYZ have outstanding? C2. What is the price per share of the firm’s stock? d. Construct XYZ’s market value balance sheet after the purchase has been made. 4. Suppose XYZ decides to issue debt to finance the purchase. a. What will the market value of the XYZ company be if the purchase is financed with debt? b. Construct XYZ’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 XYZ’s stock? 6. What is the breakeven point EBIT and the corresponding EPS
XYZ company is entirely equity financed, with 12 million shares of common stock outstanding. The stock
currently trades at $48.50 per share. XYZ is evaluating a growth project which will cost $45 million. The
project will bring in $11 million earnings (cash flows) per year in perpetuity.
XYZ’s current cost of capital is 11.5 percent. The company could be more valuable if it included debt in
its capital structure, so XYZ management is evaluating whether the company should issue debt to
entirely finance the project. If the company uses debt, then the debt will carry a 7% interest expense.
XYZ has a 40 percent corporate tax rate (state and federal).
1. If XYZ wishes to maximize its total market value, would you recommend that it issue debt or equity
to finance the land purchase? Explain.
2. Construct XYZ’s market value balance sheet before it announces the purchase.
3. Suppose XYZ decides to issue equity to finance the purchase.
a. What is the net present value of the project?
b. Construct XYZ’s market value balance sheet after it announces that the firm will finance the
purchase using equity. b1. What would be the new price per share of the firm’s stock? b2.
How many shares will XYZ need to issue to finance the purchase?
c. Construct XYZ’s market value balance sheet after the equity issue but before the purchase
has been made. c1. How many shares of common stock does XYZ have outstanding? C2. What
is the price per share of the firm’s stock?
d. Construct XYZ’s market value balance sheet after the purchase has been made.
4. Suppose XYZ decides to issue debt to finance the purchase.
a. What will the market value of the XYZ company be if the purchase is financed with debt?
b. Construct XYZ’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 XYZ’s stock?
6. What is the breakeven point EBIT and the corresponding EPS
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