The NPV ( Net present value ) of the project. Case synopsis: Company S is a real estate firm, whose CEO (chief executive officer) is Person R. The firm buys a real estate and rents it to the tenants. The firm gains profit every year. Before the foundation of Company S, Person R was the CEO and the founder of Company A, which is a farming operation. Company A was a failure firm, which ends up with bankruptcy. This situation made Person R to be extremely averse towards debt financing. Hence, the company is completely financed through equity. Company S is assessing a plan to buy a huge tract of land, which would be leased to the tenant farmers. This purchase is predicted to raise the annual earnings before tax in perpetuity. Person J is the new CFO (chief financial officer) of Company S, who has found the present capital cost of the company. Person J felt that the company will be very valuable if it adds debt in its capital structure. While evaluating whether the company could issue debt to completely finance the project, she found that it can issue bonds at a par value with the coupon rate. She also found an optimal range of capital structure between 70% equity and 30% debt to maximize its value. Characters in the case: Company S Company A Person S Person J Adequate information : If Company S moves beyond the 30% debt, the bonds issued by the company will have a lower rating and a greater coupon, which is the possibility of financial distress and the associated cost would increase. Company S also has a corporate rate of tax.

Question

Want to see more full solutions like this?

Answer 1

Question

Definition Definition Financial statement that provides a snapshot of an organization's financial position at a specific point in time. It summarizes a company's assets, liabilities, and shareholder's equity, detailing what the company owns, what it owes, and what is left over for its owners. The balance sheet serves as a crucial tool to assess the financial health and stability of a company, as well as to help management make informed decisions about its future investments and financial obligations.

Chapter 16, Problem 3M

a)

Summary Introduction

To compute: The NPV (Net present value) of the project.

Case synopsis:

Company S is a real estate firm, whose CEO (chief executive officer) is Person R. The firm buys a real estate and rents it to the tenants. The firm gains profit every year. Before the foundation of Company S, Person R was the CEO and the founder of Company A, which is a farming operation. Company A was a failure firm, which ends up with bankruptcy. This situation made Person R to be extremely averse towards debt financing.

Hence, the company is completely financed through equity. Company S is assessing a plan to buy a huge tract of land, which would be leased to the tenant farmers. This purchase is predicted to raise the annual earnings before tax in perpetuity. Person J is the new CFO (chief financial officer) of Company S, who has found the present capital cost of the company.

Person J felt that the company will be very valuable if it adds debt in its capital structure. While evaluating whether the company could issue debt to completely finance the project, she found that it can issue bonds at a par value with the coupon rate. She also found an optimal range of capital structure between 70% equity and 30% debt to maximize its value.

Characters in the case:

Company S

Company A

Person S

Person J

Adequate information:

If Company S moves beyond the 30% debt, the bonds issued by the company will have a lower rating and a greater coupon, which is the possibility of financial distress and the associated cost would increase.

Company S also has a corporate rate of tax.

a)

Expert Solution

Answer to Problem 3M

The NPV of the project $15,294,118.

Explanation of Solution

Given information: Company S has the outstanding stock of 9 million shares, while financed completely through equity. The present trade of the stock is $37.80 per share. The purchase price of the huge tract of land is $95 million. The expected increase in the earnings through the land purchase is $18.75 million.

The present capital cost of the company is 10.2%. The company will have an optimal capital structure if it is between 70% equity and 30% debt. The corporate rate of tax is 40%.

Explanation:

The purchase of land will result with an increase in the earnings of the company by $18.75 million per year in perpetuity. Such earnings are taxed at 40%. Hence, after taxes, the land purchase will increase the yearly-expected earnings of the company.

Formula to calculate the increase in the earnings:

Earnings increase=Increase in purchase before tax(1−Rate of tax)

Calculate the increase in the earnings:

Earnings increase=Increase in purchase before tax(1−Rate of tax)=$18,750,000(1−0.40)=$11,250,000

Hence, the increase in the earnings after tax is $11,250,000.

As Company S is an all-equity company, the appropriate rate of discount is the company’s unlevered cost of equity. Hence, the NPV of the purchase is as follows:

Formula to calculate the NPV:

NPV=Increase in the earnings after-taxCurrent cost of capital−Initial cost

Calculate the NPV:

NPV=Increase in the earnings after-taxCurrent cost of capital−Initial cost=$11,250,0000.102−$95,000,000=$15,294,118

Hence, the NPV is $15,294,118.

b)

Summary Introduction

To construct: The balance sheet of Company S with its market value after its announcement that the company will use equity finance for the purchase, calculate the new price per share of the company’s stock and the number of shares required by the company to issue in order to finance the purchase.

The value of Company S will maximize by $15,294,118, which is NPV of the purchase, after the announcement. As per the efficient-market hypothesis, the firm’s market value will immediately increase to reflect the project’s NPV.

Case synopsis:

Company S is a real estate firm, whose CEO (chief executive officer) is Person R. The firm buys a real estate and rents it to the tenants. The firm gains profit every year. Before the foundation of Company S, Person R was the CEO and the founder of Company A, which is a farming operation. Company A was a failure firm, which ends up with bankruptcy. This situation made Person R to be extremely averse towards debt financing.

Hence, the company is completely financed through equity. Company S is assessing a plan to buy a huge tract of land, which would be leased to the tenant farmers. This purchase is predicted to raise the annual earnings before tax in perpetuity. Person J is the new CFO (chief financial officer) of Company S, who has found the present capital cost of the company.

Person J felt that the company will be very valuable if it adds debt in its capital structure. While evaluating whether the company could issue debt to completely finance the project, she found that it can issue bonds at a par value with the coupon rate. She also found an optimal range of capital structure between 70% equity and 30% debt to maximize its value.

Characters in the case:

Company S

Company A

Person S

Person J

Adequate information:

If Company S moves beyond the 30% debt, the bonds issued by the company will have a lower rating and a greater coupon, which is the possibility of financial distress and the associated cost would increase.

Company S also has a corporate rate of tax.

b)

Expert Solution

Answer to Problem 3M

The new price per share after the announcement of land purchase is $ 39.50 and the number of shares Company S needs to issue is $2,405,103.

Explanation of Solution

Given information:

Company S has the outstanding stock of 9 million shares, while financed completely through equity. The present trade of the stock is $37.80 per share. The purchase price of the huge tract of land is $95 million. The expected increase in the earnings through the land purchase is $18.75 million.

Explanation:

The market value equity of Company S after the purchase announcement is as follows:

The present capital cost of the company is 10.2%. The company will have an optimal capital structure if it is between 70% equity and 30% debt. The corporate rate of tax is 40%.

Formula to calculate the value of equity:

Equity value=Market value of equity+NPV

Calculate the value of equity:

Equity value=Market value of equity+NPV=$340,200,000+$15,294,118=$355,494,118

Hence, the equity value is $355,494,118.

Balance sheet showing the market value after its announcement of land purchase through equity finance:

Market value balance sheet
Equity	$355,494,118	Old assets	$340,200,000
		NPV of project	$15,294,118
Debt and equity	$355,494,118	Total assets	$355,494,118

As the market value of the company’s equity is $355,494,118 and the company has an outstanding stock of 9 million shares, the stock price of Company S after the announcement will be as follows:

Formula to calculate the new share price:

New share price=Market value of the firm's equityOutstanding shares

Calculate the new share price:

New share price=Market value of the firm's equityOutstanding shares=$355,494,118$9,000,000=$39.50

Hence, the new share price is $39.50.

Company S should increase $95 million to finance the purchase of land and the worth of the company’s stock is $39.50 per share. Hence, Company S must issue the amount as follows:

Formula to calculate the shares to be issued:

Shares to issue=Increase in the financing amount for land purchaseNew share price

Calculate the shares to be issued:

Shares to issue=Increase in the financing amount for land purchaseNew share price=$95,000,000$39.50=$2,405,103

Hence, the shares to be issued are $2,405,103.

c)

Summary Introduction

To construct: The balance sheet of Company S with its market value after the issue of equity prior to the purchase, calculate the new price per share of the company’s stock and the outstanding number of shares of the common stock that the company has owned.

Company S will receive a cash of $95 million due to equity issue. This will raise the assets and equity of the firm by $95 million. Hence, the balance sheet with the new market value after the issue of stock will be as follows:

Case synopsis:

Company S is a real estate firm, whose CEO (chief executive officer) is Person R. The firm buys a real estate and rents it to the tenants. The firm gains profit every year. Before the foundation of Company S, Person R was the CEO and the founder of Company A, which is a farming operation. Company A was a failure firm, which ends up with bankruptcy. This situation made Person R to be extremely averse towards debt financing.

Hence, the company is completely financed through equity. Company S is assessing a plan to buy a huge tract of land, which would be leased to the tenant farmers. This purchase is predicted to raise the annual earnings before tax in perpetuity. Person J is the new CFO (chief financial officer) of Company S, who has found the present capital cost of the company.

Person J felt that the company will be very valuable if it adds debt in its capital structure. While evaluating whether the company could issue debt to completely finance the project, she found that it can issue bonds at a par value with the coupon rate. She also found an optimal range of capital structure between 70% equity and 30% debt to maximize its value.

Characters in the case:

Company S

Company A

Person S

Person J

Adequate information:

If Company S moves beyond the 30% debt, the bonds issued by the company will have a lower rating and a greater coupon, which is the possibility of financial distress and the associated cost would increase.

Company S also has a corporate rate of tax.

c)

Expert Solution

Answer to Problem 3M

The outstanding number of shares of common stock that the company has is $11,405,103 and the price per share of the company’s stock is $39.50.

Explanation of Solution

Given information: Company S has the outstanding stock of 9 million shares, while financed completely through equity. The present trade of the stock is $37.80 per share. The purchase price of the huge tract of land is $95 million. The expected increase in the earnings through the land purchase is $18.75 million.

The present capital cost of the company is 10.2%. The company will have an optimal capital structure if it is between 70% equity and 30% debt. The corporate rate of tax is 40%.

Balance sheet showing the market value before the land purchase after the issue of stock:

Market Value Balance Sheet
Equity	$450,494,118	Cash	$95,000,000
		Old assets	$340,200,000
		NPV of project	$15,294,118
Debt and equity	$450,494,118	Total assets	$450,494,118

The stock price will remain unchanged. Hence, compute the total outstanding shares to show the constant stock price.

Formula to calculate the total outstanding shares:

Total shares outstanding=Outstanding shares+Number of shares to be issued

Calculate the total outstanding shares:

Total shares outstanding=Outstanding shares+Number of shares to be issued=$9,000,000+$2,405,103=$11,405,103

Hence, the total outstanding shares is $11,405,103.

Formula to calculate the share price:

Share price=EquityTotal shares outstanding

Calculate the share price:

Share price=EquityTotal shares outstanding=$450,494,118$11,405,103=$39.50

Hence, the share price is $39.50.

d)

Summary Introduction

To construct: The balance sheet of Company S after the purchase.

The project will increase by $18.75 million of extra pretax earnings per year forever. Such earnings will taxed at 40%. Hence, after taxes, the project will raise the yearly earnings of the firm by $11.25 million. Compute the present value of the increase in the earnings after-tax:

Case synopsis:

Company S is a real estate firm, whose CEO (chief executive officer) is Person R. The firm buys a real estate and rents it to the tenants. The firm gains profit every year. Before the foundation of Company S, Person R was the CEO and the founder of Company A, which is a farming operation. Company A was a failure firm, which ends up with bankruptcy. This situation made Person R to be extremely averse towards debt financing.

Hence, the company is completely financed through equity. Company S is assessing a plan to buy a huge tract of land, which would be leased to the tenant farmers. This purchase is predicted to raise the annual earnings before tax in perpetuity. Person J is the new CFO (chief financial officer) of Company S, who has found the present capital cost of the company.

Person J felt that the company will be very valuable if it adds debt in its capital structure. While evaluating whether the company could issue debt to completely finance the project, she found that it can issue bonds at a par value with the coupon rate. She also found an optimal range of capital structure between 70% equity and 30% debt to maximize its value.

Characters in the case:

Company S

Company A

Person S

Person J

Adequate information:

If Company S moves beyond the 30% debt, the bonds issued by the company will have a lower rating and a greater coupon, which is the possibility of financial distress and the associated cost would increase.

Company S also has a corporate rate of tax.

d)

Expert Solution

Explanation of Solution

Given information: Company S has the outstanding stock of 9 million shares, while financed completely through equity. The present trade of the stock is $37.80 per share. The purchase price of the huge tract of land is $95 million. The expected increase in the earnings through the land purchase is $18.75 million.

The present capital cost of the company is 10.2%. The company will have an optimal capital structure if it is between 70% equity and 30% debt. The corporate rate of tax is 40%.

Formula to calculate the market value balance sheet:

Present value of the project=Increase in the yearly earnings of the firm Present capital cost

Calculate the market value balance sheet:

Present value of the project=Increase in the yearly earnings of the firm Present capital cost=$11,250,000$0.102=$110,294,118

Hence, the present value of the project is $110,294,118.

Balance sheet showing the market value after the land purchase has been made after the issue of stock:

Market Value Balance Sheet
Equity	$450,494,118	Old assets	$340,200,000
		PV of project	$110,294,118
Debt and equity	$450,494,118	Total assets	$450,494,118

Want to see more full solutions like this?

Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!

Students have asked these similar questions

John's Auto is a successful business that has a substantial profit each year. The auto dealership has purchased an antique car for $11,000. John, the proprietor, is almost certain that it will go up in price, and from the research he has done he believes that he can sell the car for $18,000 in 4 years. Although he plans to sell the car for more than it is worth currently, the government still allows him to claim depreciation at a CCA rate of 30%. Maria, one of his accountants, says John should not bother claim CCA because it won't save him money overall, and it will just mean he will have to pay back all his tax savings from years 1 to 3 at the end of year 4. Another accountant, Jesse, claims that John should still depreciate the vehicle each year because it will save him money overall, even though he will probably have to pay the government a significant amount of tax in year 4. What should John do and why? Support your answer with detailed calculations (hint: develop a very…

You purchased a small company for $50,000 (in year zero). Unfortunately, things did not go well and your company lost $2,500 each year for the first three years. To alleviate the situation, during the third year, you decided to invest an additional $12,000 in the company. This smart decision resulted in a profit of $11,000 each year from the fourth year through the 16th year. At the end of 16 years the company can be sold for $40,000.Calculate the internal rate of return (IRR) as well as the NPV if MARR = 12%. Neglect depreciation or taxes in this problem.

Raul Martinas, a professor of languages at Eastern University, owns a small office building adjacent to the university campus. He acquired the property 10 years ago at a total cost of $559,000—that is, $52,000 for the land and $507,000 for the building. He has just received an offer from a realty company that wants to purchase the property; however, the property has been a good source of income over the years, and so Martinas is unsure whether he should keep it or sell it. His alternatives are as follows: a. Keep the property. Martinas’s accountant has kept careful records of the income realized from the property over the past 10 years. These records indicate the following annual revenues and expenses: Martinas makes a $12,675 mortgage payment each year on the property. The mortgage will be paid off in eight more years. He has been depreciating the building by the straight-line method, assuming a salvage value of $76,050 for the building, which he still thinks is an appropriate figure.…

Answer 2

Question

Definition Definition Financial statement that provides a snapshot of an organization's financial position at a specific point in time. It summarizes a company's assets, liabilities, and shareholder's equity, detailing what the company owns, what it owes, and what is left over for its owners. The balance sheet serves as a crucial tool to assess the financial health and stability of a company, as well as to help management make informed decisions about its future investments and financial obligations.

Chapter 16, Problem 3M

a)

Summary Introduction

To compute: The NPV (Net present value) of the project.

Case synopsis:

Company S is a real estate firm, whose CEO (chief executive officer) is Person R. The firm buys a real estate and rents it to the tenants. The firm gains profit every year. Before the foundation of Company S, Person R was the CEO and the founder of Company A, which is a farming operation. Company A was a failure firm, which ends up with bankruptcy. This situation made Person R to be extremely averse towards debt financing.

Hence, the company is completely financed through equity. Company S is assessing a plan to buy a huge tract of land, which would be leased to the tenant farmers. This purchase is predicted to raise the annual earnings before tax in perpetuity. Person J is the new CFO (chief financial officer) of Company S, who has found the present capital cost of the company.

Person J felt that the company will be very valuable if it adds debt in its capital structure. While evaluating whether the company could issue debt to completely finance the project, she found that it can issue bonds at a par value with the coupon rate. She also found an optimal range of capital structure between 70% equity and 30% debt to maximize its value.

Characters in the case:

Company S

Company A

Person S

Person J

Adequate information:

If Company S moves beyond the 30% debt, the bonds issued by the company will have a lower rating and a greater coupon, which is the possibility of financial distress and the associated cost would increase.

Company S also has a corporate rate of tax.

a)

Expert Solution

Answer to Problem 3M

The NPV of the project $15,294,118.

Explanation of Solution

Given information: Company S has the outstanding stock of 9 million shares, while financed completely through equity. The present trade of the stock is $37.80 per share. The purchase price of the huge tract of land is $95 million. The expected increase in the earnings through the land purchase is $18.75 million.

The present capital cost of the company is 10.2%. The company will have an optimal capital structure if it is between 70% equity and 30% debt. The corporate rate of tax is 40%.

Explanation:

The purchase of land will result with an increase in the earnings of the company by $18.75 million per year in perpetuity. Such earnings are taxed at 40%. Hence, after taxes, the land purchase will increase the yearly-expected earnings of the company.

Formula to calculate the increase in the earnings:

Earnings increase=Increase in purchase before tax(1−Rate of tax)

Calculate the increase in the earnings:

Earnings increase=Increase in purchase before tax(1−Rate of tax)=$18,750,000(1−0.40)=$11,250,000

Hence, the increase in the earnings after tax is $11,250,000.

As Company S is an all-equity company, the appropriate rate of discount is the company’s unlevered cost of equity. Hence, the NPV of the purchase is as follows:

Formula to calculate the NPV:

NPV=Increase in the earnings after-taxCurrent cost of capital−Initial cost

Calculate the NPV:

NPV=Increase in the earnings after-taxCurrent cost of capital−Initial cost=$11,250,0000.102−$95,000,000=$15,294,118

Hence, the NPV is $15,294,118.

b)

Summary Introduction

To construct: The balance sheet of Company S with its market value after its announcement that the company will use equity finance for the purchase, calculate the new price per share of the company’s stock and the number of shares required by the company to issue in order to finance the purchase.

The value of Company S will maximize by $15,294,118, which is NPV of the purchase, after the announcement. As per the efficient-market hypothesis, the firm’s market value will immediately increase to reflect the project’s NPV.

Case synopsis:

Company S is a real estate firm, whose CEO (chief executive officer) is Person R. The firm buys a real estate and rents it to the tenants. The firm gains profit every year. Before the foundation of Company S, Person R was the CEO and the founder of Company A, which is a farming operation. Company A was a failure firm, which ends up with bankruptcy. This situation made Person R to be extremely averse towards debt financing.

Hence, the company is completely financed through equity. Company S is assessing a plan to buy a huge tract of land, which would be leased to the tenant farmers. This purchase is predicted to raise the annual earnings before tax in perpetuity. Person J is the new CFO (chief financial officer) of Company S, who has found the present capital cost of the company.

Person J felt that the company will be very valuable if it adds debt in its capital structure. While evaluating whether the company could issue debt to completely finance the project, she found that it can issue bonds at a par value with the coupon rate. She also found an optimal range of capital structure between 70% equity and 30% debt to maximize its value.

Characters in the case:

Company S

Company A

Person S

Person J

Adequate information:

If Company S moves beyond the 30% debt, the bonds issued by the company will have a lower rating and a greater coupon, which is the possibility of financial distress and the associated cost would increase.

Company S also has a corporate rate of tax.

b)

Expert Solution

Answer to Problem 3M

The new price per share after the announcement of land purchase is $ 39.50 and the number of shares Company S needs to issue is $2,405,103.

Explanation of Solution

Given information:

Company S has the outstanding stock of 9 million shares, while financed completely through equity. The present trade of the stock is $37.80 per share. The purchase price of the huge tract of land is $95 million. The expected increase in the earnings through the land purchase is $18.75 million.

Explanation:

The market value equity of Company S after the purchase announcement is as follows:

The present capital cost of the company is 10.2%. The company will have an optimal capital structure if it is between 70% equity and 30% debt. The corporate rate of tax is 40%.

Formula to calculate the value of equity:

Equity value=Market value of equity+NPV

Calculate the value of equity:

Equity value=Market value of equity+NPV=$340,200,000+$15,294,118=$355,494,118

Hence, the equity value is $355,494,118.

Balance sheet showing the market value after its announcement of land purchase through equity finance:

Market value balance sheet
Equity	$355,494,118	Old assets	$340,200,000
		NPV of project	$15,294,118
Debt and equity	$355,494,118	Total assets	$355,494,118

As the market value of the company’s equity is $355,494,118 and the company has an outstanding stock of 9 million shares, the stock price of Company S after the announcement will be as follows:

Formula to calculate the new share price:

New share price=Market value of the firm's equityOutstanding shares

Calculate the new share price:

New share price=Market value of the firm's equityOutstanding shares=$355,494,118$9,000,000=$39.50

Hence, the new share price is $39.50.

Company S should increase $95 million to finance the purchase of land and the worth of the company’s stock is $39.50 per share. Hence, Company S must issue the amount as follows:

Formula to calculate the shares to be issued:

Shares to issue=Increase in the financing amount for land purchaseNew share price

Calculate the shares to be issued:

Shares to issue=Increase in the financing amount for land purchaseNew share price=$95,000,000$39.50=$2,405,103

Hence, the shares to be issued are $2,405,103.

c)

Summary Introduction

To construct: The balance sheet of Company S with its market value after the issue of equity prior to the purchase, calculate the new price per share of the company’s stock and the outstanding number of shares of the common stock that the company has owned.

Company S will receive a cash of $95 million due to equity issue. This will raise the assets and equity of the firm by $95 million. Hence, the balance sheet with the new market value after the issue of stock will be as follows:

Case synopsis:

Company S is a real estate firm, whose CEO (chief executive officer) is Person R. The firm buys a real estate and rents it to the tenants. The firm gains profit every year. Before the foundation of Company S, Person R was the CEO and the founder of Company A, which is a farming operation. Company A was a failure firm, which ends up with bankruptcy. This situation made Person R to be extremely averse towards debt financing.

Hence, the company is completely financed through equity. Company S is assessing a plan to buy a huge tract of land, which would be leased to the tenant farmers. This purchase is predicted to raise the annual earnings before tax in perpetuity. Person J is the new CFO (chief financial officer) of Company S, who has found the present capital cost of the company.

Person J felt that the company will be very valuable if it adds debt in its capital structure. While evaluating whether the company could issue debt to completely finance the project, she found that it can issue bonds at a par value with the coupon rate. She also found an optimal range of capital structure between 70% equity and 30% debt to maximize its value.

Characters in the case:

Company S

Company A

Person S

Person J

Adequate information:

If Company S moves beyond the 30% debt, the bonds issued by the company will have a lower rating and a greater coupon, which is the possibility of financial distress and the associated cost would increase.

Company S also has a corporate rate of tax.

c)

Expert Solution

Answer to Problem 3M

The outstanding number of shares of common stock that the company has is $11,405,103 and the price per share of the company’s stock is $39.50.

Explanation of Solution

Given information: Company S has the outstanding stock of 9 million shares, while financed completely through equity. The present trade of the stock is $37.80 per share. The purchase price of the huge tract of land is $95 million. The expected increase in the earnings through the land purchase is $18.75 million.

The present capital cost of the company is 10.2%. The company will have an optimal capital structure if it is between 70% equity and 30% debt. The corporate rate of tax is 40%.

Balance sheet showing the market value before the land purchase after the issue of stock:

Market Value Balance Sheet
Equity	$450,494,118	Cash	$95,000,000
		Old assets	$340,200,000
		NPV of project	$15,294,118
Debt and equity	$450,494,118	Total assets	$450,494,118

The stock price will remain unchanged. Hence, compute the total outstanding shares to show the constant stock price.

Formula to calculate the total outstanding shares:

Total shares outstanding=Outstanding shares+Number of shares to be issued

Calculate the total outstanding shares:

Total shares outstanding=Outstanding shares+Number of shares to be issued=$9,000,000+$2,405,103=$11,405,103

Hence, the total outstanding shares is $11,405,103.

Formula to calculate the share price:

Share price=EquityTotal shares outstanding

Calculate the share price:

Share price=EquityTotal shares outstanding=$450,494,118$11,405,103=$39.50

Hence, the share price is $39.50.

d)

Summary Introduction

To construct: The balance sheet of Company S after the purchase.

The project will increase by $18.75 million of extra pretax earnings per year forever. Such earnings will taxed at 40%. Hence, after taxes, the project will raise the yearly earnings of the firm by $11.25 million. Compute the present value of the increase in the earnings after-tax:

Case synopsis:

Company S is a real estate firm, whose CEO (chief executive officer) is Person R. The firm buys a real estate and rents it to the tenants. The firm gains profit every year. Before the foundation of Company S, Person R was the CEO and the founder of Company A, which is a farming operation. Company A was a failure firm, which ends up with bankruptcy. This situation made Person R to be extremely averse towards debt financing.

Hence, the company is completely financed through equity. Company S is assessing a plan to buy a huge tract of land, which would be leased to the tenant farmers. This purchase is predicted to raise the annual earnings before tax in perpetuity. Person J is the new CFO (chief financial officer) of Company S, who has found the present capital cost of the company.

Person J felt that the company will be very valuable if it adds debt in its capital structure. While evaluating whether the company could issue debt to completely finance the project, she found that it can issue bonds at a par value with the coupon rate. She also found an optimal range of capital structure between 70% equity and 30% debt to maximize its value.

Characters in the case:

Company S

Company A

Person S

Person J

Adequate information:

If Company S moves beyond the 30% debt, the bonds issued by the company will have a lower rating and a greater coupon, which is the possibility of financial distress and the associated cost would increase.

Company S also has a corporate rate of tax.

d)

Expert Solution

Explanation of Solution

Given information: Company S has the outstanding stock of 9 million shares, while financed completely through equity. The present trade of the stock is $37.80 per share. The purchase price of the huge tract of land is $95 million. The expected increase in the earnings through the land purchase is $18.75 million.

The present capital cost of the company is 10.2%. The company will have an optimal capital structure if it is between 70% equity and 30% debt. The corporate rate of tax is 40%.

Formula to calculate the market value balance sheet:

Present value of the project=Increase in the yearly earnings of the firm Present capital cost

Calculate the market value balance sheet:

Present value of the project=Increase in the yearly earnings of the firm Present capital cost=$11,250,000$0.102=$110,294,118

Hence, the present value of the project is $110,294,118.

Balance sheet showing the market value after the land purchase has been made after the issue of stock:

Market Value Balance Sheet
Equity	$450,494,118	Old assets	$340,200,000
		PV of project	$110,294,118
Debt and equity	$450,494,118	Total assets	$450,494,118

Want to see more full solutions like this?

Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!

Answer 3

Question

Definition Definition Financial statement that provides a snapshot of an organization's financial position at a specific point in time. It summarizes a company's assets, liabilities, and shareholder's equity, detailing what the company owns, what it owes, and what is left over for its owners. The balance sheet serves as a crucial tool to assess the financial health and stability of a company, as well as to help management make informed decisions about its future investments and financial obligations.

Chapter 16, Problem 3M

a)

Summary Introduction

To compute: The NPV (Net present value) of the project.

Case synopsis:

Company S is a real estate firm, whose CEO (chief executive officer) is Person R. The firm buys a real estate and rents it to the tenants. The firm gains profit every year. Before the foundation of Company S, Person R was the CEO and the founder of Company A, which is a farming operation. Company A was a failure firm, which ends up with bankruptcy. This situation made Person R to be extremely averse towards debt financing.

Hence, the company is completely financed through equity. Company S is assessing a plan to buy a huge tract of land, which would be leased to the tenant farmers. This purchase is predicted to raise the annual earnings before tax in perpetuity. Person J is the new CFO (chief financial officer) of Company S, who has found the present capital cost of the company.

Person J felt that the company will be very valuable if it adds debt in its capital structure. While evaluating whether the company could issue debt to completely finance the project, she found that it can issue bonds at a par value with the coupon rate. She also found an optimal range of capital structure between 70% equity and 30% debt to maximize its value.

Characters in the case:

Company S

Company A

Person S

Person J

Adequate information:

If Company S moves beyond the 30% debt, the bonds issued by the company will have a lower rating and a greater coupon, which is the possibility of financial distress and the associated cost would increase.

Company S also has a corporate rate of tax.

a)

Expert Solution

Answer to Problem 3M

The NPV of the project $15,294,118.

Explanation of Solution

Given information: Company S has the outstanding stock of 9 million shares, while financed completely through equity. The present trade of the stock is $37.80 per share. The purchase price of the huge tract of land is $95 million. The expected increase in the earnings through the land purchase is $18.75 million.

The present capital cost of the company is 10.2%. The company will have an optimal capital structure if it is between 70% equity and 30% debt. The corporate rate of tax is 40%.

Explanation:

The purchase of land will result with an increase in the earnings of the company by $18.75 million per year in perpetuity. Such earnings are taxed at 40%. Hence, after taxes, the land purchase will increase the yearly-expected earnings of the company.

Formula to calculate the increase in the earnings:

Earnings increase=Increase in purchase before tax(1−Rate of tax)

Calculate the increase in the earnings:

Earnings increase=Increase in purchase before tax(1−Rate of tax)=$18,750,000(1−0.40)=$11,250,000

Hence, the increase in the earnings after tax is $11,250,000.

As Company S is an all-equity company, the appropriate rate of discount is the company’s unlevered cost of equity. Hence, the NPV of the purchase is as follows:

Formula to calculate the NPV:

NPV=Increase in the earnings after-taxCurrent cost of capital−Initial cost

Calculate the NPV:

NPV=Increase in the earnings after-taxCurrent cost of capital−Initial cost=$11,250,0000.102−$95,000,000=$15,294,118

Hence, the NPV is $15,294,118.

b)

Summary Introduction

To construct: The balance sheet of Company S with its market value after its announcement that the company will use equity finance for the purchase, calculate the new price per share of the company’s stock and the number of shares required by the company to issue in order to finance the purchase.

The value of Company S will maximize by $15,294,118, which is NPV of the purchase, after the announcement. As per the efficient-market hypothesis, the firm’s market value will immediately increase to reflect the project’s NPV.

Case synopsis:

Company S is a real estate firm, whose CEO (chief executive officer) is Person R. The firm buys a real estate and rents it to the tenants. The firm gains profit every year. Before the foundation of Company S, Person R was the CEO and the founder of Company A, which is a farming operation. Company A was a failure firm, which ends up with bankruptcy. This situation made Person R to be extremely averse towards debt financing.

Hence, the company is completely financed through equity. Company S is assessing a plan to buy a huge tract of land, which would be leased to the tenant farmers. This purchase is predicted to raise the annual earnings before tax in perpetuity. Person J is the new CFO (chief financial officer) of Company S, who has found the present capital cost of the company.

Person J felt that the company will be very valuable if it adds debt in its capital structure. While evaluating whether the company could issue debt to completely finance the project, she found that it can issue bonds at a par value with the coupon rate. She also found an optimal range of capital structure between 70% equity and 30% debt to maximize its value.

Characters in the case:

Company S

Company A

Person S

Person J

Adequate information:

If Company S moves beyond the 30% debt, the bonds issued by the company will have a lower rating and a greater coupon, which is the possibility of financial distress and the associated cost would increase.

Company S also has a corporate rate of tax.

b)

Expert Solution

Answer to Problem 3M

The new price per share after the announcement of land purchase is $ 39.50 and the number of shares Company S needs to issue is $2,405,103.

Explanation of Solution

Given information:

Company S has the outstanding stock of 9 million shares, while financed completely through equity. The present trade of the stock is $37.80 per share. The purchase price of the huge tract of land is $95 million. The expected increase in the earnings through the land purchase is $18.75 million.

Explanation:

The market value equity of Company S after the purchase announcement is as follows:

The present capital cost of the company is 10.2%. The company will have an optimal capital structure if it is between 70% equity and 30% debt. The corporate rate of tax is 40%.

Formula to calculate the value of equity:

Equity value=Market value of equity+NPV

Calculate the value of equity:

Equity value=Market value of equity+NPV=$340,200,000+$15,294,118=$355,494,118

Hence, the equity value is $355,494,118.

Balance sheet showing the market value after its announcement of land purchase through equity finance:

Market value balance sheet
Equity	$355,494,118	Old assets	$340,200,000
		NPV of project	$15,294,118
Debt and equity	$355,494,118	Total assets	$355,494,118

As the market value of the company’s equity is $355,494,118 and the company has an outstanding stock of 9 million shares, the stock price of Company S after the announcement will be as follows:

Formula to calculate the new share price:

New share price=Market value of the firm's equityOutstanding shares

Calculate the new share price:

New share price=Market value of the firm's equityOutstanding shares=$355,494,118$9,000,000=$39.50

Hence, the new share price is $39.50.

Company S should increase $95 million to finance the purchase of land and the worth of the company’s stock is $39.50 per share. Hence, Company S must issue the amount as follows:

Formula to calculate the shares to be issued:

Shares to issue=Increase in the financing amount for land purchaseNew share price

Calculate the shares to be issued:

Shares to issue=Increase in the financing amount for land purchaseNew share price=$95,000,000$39.50=$2,405,103

Hence, the shares to be issued are $2,405,103.

c)

Summary Introduction

To construct: The balance sheet of Company S with its market value after the issue of equity prior to the purchase, calculate the new price per share of the company’s stock and the outstanding number of shares of the common stock that the company has owned.

Company S will receive a cash of $95 million due to equity issue. This will raise the assets and equity of the firm by $95 million. Hence, the balance sheet with the new market value after the issue of stock will be as follows:

Case synopsis:

Company S is a real estate firm, whose CEO (chief executive officer) is Person R. The firm buys a real estate and rents it to the tenants. The firm gains profit every year. Before the foundation of Company S, Person R was the CEO and the founder of Company A, which is a farming operation. Company A was a failure firm, which ends up with bankruptcy. This situation made Person R to be extremely averse towards debt financing.

Hence, the company is completely financed through equity. Company S is assessing a plan to buy a huge tract of land, which would be leased to the tenant farmers. This purchase is predicted to raise the annual earnings before tax in perpetuity. Person J is the new CFO (chief financial officer) of Company S, who has found the present capital cost of the company.

Person J felt that the company will be very valuable if it adds debt in its capital structure. While evaluating whether the company could issue debt to completely finance the project, she found that it can issue bonds at a par value with the coupon rate. She also found an optimal range of capital structure between 70% equity and 30% debt to maximize its value.

Characters in the case:

Company S

Company A

Person S

Person J

Adequate information:

If Company S moves beyond the 30% debt, the bonds issued by the company will have a lower rating and a greater coupon, which is the possibility of financial distress and the associated cost would increase.

Company S also has a corporate rate of tax.

c)

Expert Solution

Answer to Problem 3M

The outstanding number of shares of common stock that the company has is $11,405,103 and the price per share of the company’s stock is $39.50.

Explanation of Solution

Given information: Company S has the outstanding stock of 9 million shares, while financed completely through equity. The present trade of the stock is $37.80 per share. The purchase price of the huge tract of land is $95 million. The expected increase in the earnings through the land purchase is $18.75 million.

The present capital cost of the company is 10.2%. The company will have an optimal capital structure if it is between 70% equity and 30% debt. The corporate rate of tax is 40%.

Balance sheet showing the market value before the land purchase after the issue of stock:

Market Value Balance Sheet
Equity	$450,494,118	Cash	$95,000,000
		Old assets	$340,200,000
		NPV of project	$15,294,118
Debt and equity	$450,494,118	Total assets	$450,494,118

The stock price will remain unchanged. Hence, compute the total outstanding shares to show the constant stock price.

Formula to calculate the total outstanding shares:

Total shares outstanding=Outstanding shares+Number of shares to be issued

Calculate the total outstanding shares:

Total shares outstanding=Outstanding shares+Number of shares to be issued=$9,000,000+$2,405,103=$11,405,103

Hence, the total outstanding shares is $11,405,103.

Formula to calculate the share price:

Share price=EquityTotal shares outstanding

Calculate the share price:

Share price=EquityTotal shares outstanding=$450,494,118$11,405,103=$39.50

Hence, the share price is $39.50.

d)

Summary Introduction

To construct: The balance sheet of Company S after the purchase.

The project will increase by $18.75 million of extra pretax earnings per year forever. Such earnings will taxed at 40%. Hence, after taxes, the project will raise the yearly earnings of the firm by $11.25 million. Compute the present value of the increase in the earnings after-tax:

Case synopsis:

Company S is a real estate firm, whose CEO (chief executive officer) is Person R. The firm buys a real estate and rents it to the tenants. The firm gains profit every year. Before the foundation of Company S, Person R was the CEO and the founder of Company A, which is a farming operation. Company A was a failure firm, which ends up with bankruptcy. This situation made Person R to be extremely averse towards debt financing.

Hence, the company is completely financed through equity. Company S is assessing a plan to buy a huge tract of land, which would be leased to the tenant farmers. This purchase is predicted to raise the annual earnings before tax in perpetuity. Person J is the new CFO (chief financial officer) of Company S, who has found the present capital cost of the company.

Person J felt that the company will be very valuable if it adds debt in its capital structure. While evaluating whether the company could issue debt to completely finance the project, she found that it can issue bonds at a par value with the coupon rate. She also found an optimal range of capital structure between 70% equity and 30% debt to maximize its value.

Characters in the case:

Company S

Company A

Person S

Person J

Adequate information:

If Company S moves beyond the 30% debt, the bonds issued by the company will have a lower rating and a greater coupon, which is the possibility of financial distress and the associated cost would increase.

Company S also has a corporate rate of tax.

d)

Expert Solution

Explanation of Solution

Given information: Company S has the outstanding stock of 9 million shares, while financed completely through equity. The present trade of the stock is $37.80 per share. The purchase price of the huge tract of land is $95 million. The expected increase in the earnings through the land purchase is $18.75 million.

The present capital cost of the company is 10.2%. The company will have an optimal capital structure if it is between 70% equity and 30% debt. The corporate rate of tax is 40%.

Formula to calculate the market value balance sheet:

Present value of the project=Increase in the yearly earnings of the firm Present capital cost

Calculate the market value balance sheet:

Present value of the project=Increase in the yearly earnings of the firm Present capital cost=$11,250,000$0.102=$110,294,118

Hence, the present value of the project is $110,294,118.

Balance sheet showing the market value after the land purchase has been made after the issue of stock:

Market Value Balance Sheet
Equity	$450,494,118	Old assets	$340,200,000
		PV of project	$110,294,118
Debt and equity	$450,494,118	Total assets	$450,494,118

Want to see more full solutions like this?

Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!

Answer 4

Question

Definition Definition Financial statement that provides a snapshot of an organization's financial position at a specific point in time. It summarizes a company's assets, liabilities, and shareholder's equity, detailing what the company owns, what it owes, and what is left over for its owners. The balance sheet serves as a crucial tool to assess the financial health and stability of a company, as well as to help management make informed decisions about its future investments and financial obligations.

Chapter 16, Problem 3M

a)

Summary Introduction

To compute: The NPV (Net present value) of the project.

Case synopsis:

Company S is a real estate firm, whose CEO (chief executive officer) is Person R. The firm buys a real estate and rents it to the tenants. The firm gains profit every year. Before the foundation of Company S, Person R was the CEO and the founder of Company A, which is a farming operation. Company A was a failure firm, which ends up with bankruptcy. This situation made Person R to be extremely averse towards debt financing.

Hence, the company is completely financed through equity. Company S is assessing a plan to buy a huge tract of land, which would be leased to the tenant farmers. This purchase is predicted to raise the annual earnings before tax in perpetuity. Person J is the new CFO (chief financial officer) of Company S, who has found the present capital cost of the company.

Person J felt that the company will be very valuable if it adds debt in its capital structure. While evaluating whether the company could issue debt to completely finance the project, she found that it can issue bonds at a par value with the coupon rate. She also found an optimal range of capital structure between 70% equity and 30% debt to maximize its value.

Characters in the case:

Company S

Company A

Person S

Person J

Adequate information:

If Company S moves beyond the 30% debt, the bonds issued by the company will have a lower rating and a greater coupon, which is the possibility of financial distress and the associated cost would increase.

Company S also has a corporate rate of tax.

a)

Expert Solution

Answer to Problem 3M

The NPV of the project $15,294,118.

Explanation of Solution

Given information: Company S has the outstanding stock of 9 million shares, while financed completely through equity. The present trade of the stock is $37.80 per share. The purchase price of the huge tract of land is $95 million. The expected increase in the earnings through the land purchase is $18.75 million.

The present capital cost of the company is 10.2%. The company will have an optimal capital structure if it is between 70% equity and 30% debt. The corporate rate of tax is 40%.

Explanation:

The purchase of land will result with an increase in the earnings of the company by $18.75 million per year in perpetuity. Such earnings are taxed at 40%. Hence, after taxes, the land purchase will increase the yearly-expected earnings of the company.

Formula to calculate the increase in the earnings:

Earnings increase=Increase in purchase before tax(1−Rate of tax)

Calculate the increase in the earnings:

Earnings increase=Increase in purchase before tax(1−Rate of tax)=$18,750,000(1−0.40)=$11,250,000

Hence, the increase in the earnings after tax is $11,250,000.

As Company S is an all-equity company, the appropriate rate of discount is the company’s unlevered cost of equity. Hence, the NPV of the purchase is as follows:

Formula to calculate the NPV:

NPV=Increase in the earnings after-taxCurrent cost of capital−Initial cost

Calculate the NPV:

NPV=Increase in the earnings after-taxCurrent cost of capital−Initial cost=$11,250,0000.102−$95,000,000=$15,294,118

Hence, the NPV is $15,294,118.

b)

Summary Introduction

To construct: The balance sheet of Company S with its market value after its announcement that the company will use equity finance for the purchase, calculate the new price per share of the company’s stock and the number of shares required by the company to issue in order to finance the purchase.

The value of Company S will maximize by $15,294,118, which is NPV of the purchase, after the announcement. As per the efficient-market hypothesis, the firm’s market value will immediately increase to reflect the project’s NPV.

Case synopsis:

Company S is a real estate firm, whose CEO (chief executive officer) is Person R. The firm buys a real estate and rents it to the tenants. The firm gains profit every year. Before the foundation of Company S, Person R was the CEO and the founder of Company A, which is a farming operation. Company A was a failure firm, which ends up with bankruptcy. This situation made Person R to be extremely averse towards debt financing.

Hence, the company is completely financed through equity. Company S is assessing a plan to buy a huge tract of land, which would be leased to the tenant farmers. This purchase is predicted to raise the annual earnings before tax in perpetuity. Person J is the new CFO (chief financial officer) of Company S, who has found the present capital cost of the company.

Person J felt that the company will be very valuable if it adds debt in its capital structure. While evaluating whether the company could issue debt to completely finance the project, she found that it can issue bonds at a par value with the coupon rate. She also found an optimal range of capital structure between 70% equity and 30% debt to maximize its value.

Characters in the case:

Company S

Company A

Person S

Person J

Adequate information:

If Company S moves beyond the 30% debt, the bonds issued by the company will have a lower rating and a greater coupon, which is the possibility of financial distress and the associated cost would increase.

Company S also has a corporate rate of tax.

b)

Expert Solution

Answer to Problem 3M

The new price per share after the announcement of land purchase is $ 39.50 and the number of shares Company S needs to issue is $2,405,103.

Explanation of Solution

Given information:

Company S has the outstanding stock of 9 million shares, while financed completely through equity. The present trade of the stock is $37.80 per share. The purchase price of the huge tract of land is $95 million. The expected increase in the earnings through the land purchase is $18.75 million.

Explanation:

The market value equity of Company S after the purchase announcement is as follows:

The present capital cost of the company is 10.2%. The company will have an optimal capital structure if it is between 70% equity and 30% debt. The corporate rate of tax is 40%.

Formula to calculate the value of equity:

Equity value=Market value of equity+NPV

Calculate the value of equity:

Equity value=Market value of equity+NPV=$340,200,000+$15,294,118=$355,494,118

Hence, the equity value is $355,494,118.

Balance sheet showing the market value after its announcement of land purchase through equity finance:

Market value balance sheet
Equity	$355,494,118	Old assets	$340,200,000
		NPV of project	$15,294,118
Debt and equity	$355,494,118	Total assets	$355,494,118

As the market value of the company’s equity is $355,494,118 and the company has an outstanding stock of 9 million shares, the stock price of Company S after the announcement will be as follows:

Formula to calculate the new share price:

New share price=Market value of the firm's equityOutstanding shares

Calculate the new share price:

New share price=Market value of the firm's equityOutstanding shares=$355,494,118$9,000,000=$39.50

Hence, the new share price is $39.50.

Company S should increase $95 million to finance the purchase of land and the worth of the company’s stock is $39.50 per share. Hence, Company S must issue the amount as follows:

Formula to calculate the shares to be issued:

Shares to issue=Increase in the financing amount for land purchaseNew share price

Calculate the shares to be issued:

Shares to issue=Increase in the financing amount for land purchaseNew share price=$95,000,000$39.50=$2,405,103

Hence, the shares to be issued are $2,405,103.

c)

Summary Introduction

To construct: The balance sheet of Company S with its market value after the issue of equity prior to the purchase, calculate the new price per share of the company’s stock and the outstanding number of shares of the common stock that the company has owned.

Company S will receive a cash of $95 million due to equity issue. This will raise the assets and equity of the firm by $95 million. Hence, the balance sheet with the new market value after the issue of stock will be as follows:

Case synopsis:

Company S is a real estate firm, whose CEO (chief executive officer) is Person R. The firm buys a real estate and rents it to the tenants. The firm gains profit every year. Before the foundation of Company S, Person R was the CEO and the founder of Company A, which is a farming operation. Company A was a failure firm, which ends up with bankruptcy. This situation made Person R to be extremely averse towards debt financing.

Hence, the company is completely financed through equity. Company S is assessing a plan to buy a huge tract of land, which would be leased to the tenant farmers. This purchase is predicted to raise the annual earnings before tax in perpetuity. Person J is the new CFO (chief financial officer) of Company S, who has found the present capital cost of the company.

Person J felt that the company will be very valuable if it adds debt in its capital structure. While evaluating whether the company could issue debt to completely finance the project, she found that it can issue bonds at a par value with the coupon rate. She also found an optimal range of capital structure between 70% equity and 30% debt to maximize its value.

Characters in the case:

Company S

Company A

Person S

Person J

Adequate information:

If Company S moves beyond the 30% debt, the bonds issued by the company will have a lower rating and a greater coupon, which is the possibility of financial distress and the associated cost would increase.

Company S also has a corporate rate of tax.

c)

Expert Solution

Answer to Problem 3M

The outstanding number of shares of common stock that the company has is $11,405,103 and the price per share of the company’s stock is $39.50.

Explanation of Solution

Given information: Company S has the outstanding stock of 9 million shares, while financed completely through equity. The present trade of the stock is $37.80 per share. The purchase price of the huge tract of land is $95 million. The expected increase in the earnings through the land purchase is $18.75 million.

The present capital cost of the company is 10.2%. The company will have an optimal capital structure if it is between 70% equity and 30% debt. The corporate rate of tax is 40%.

Balance sheet showing the market value before the land purchase after the issue of stock:

Market Value Balance Sheet
Equity	$450,494,118	Cash	$95,000,000
		Old assets	$340,200,000
		NPV of project	$15,294,118
Debt and equity	$450,494,118	Total assets	$450,494,118

The stock price will remain unchanged. Hence, compute the total outstanding shares to show the constant stock price.

Formula to calculate the total outstanding shares:

Total shares outstanding=Outstanding shares+Number of shares to be issued

Calculate the total outstanding shares:

Total shares outstanding=Outstanding shares+Number of shares to be issued=$9,000,000+$2,405,103=$11,405,103

Hence, the total outstanding shares is $11,405,103.

Formula to calculate the share price:

Share price=EquityTotal shares outstanding

Calculate the share price:

Share price=EquityTotal shares outstanding=$450,494,118$11,405,103=$39.50

Hence, the share price is $39.50.

d)

Summary Introduction

To construct: The balance sheet of Company S after the purchase.

The project will increase by $18.75 million of extra pretax earnings per year forever. Such earnings will taxed at 40%. Hence, after taxes, the project will raise the yearly earnings of the firm by $11.25 million. Compute the present value of the increase in the earnings after-tax:

Case synopsis:

Company S is a real estate firm, whose CEO (chief executive officer) is Person R. The firm buys a real estate and rents it to the tenants. The firm gains profit every year. Before the foundation of Company S, Person R was the CEO and the founder of Company A, which is a farming operation. Company A was a failure firm, which ends up with bankruptcy. This situation made Person R to be extremely averse towards debt financing.

Hence, the company is completely financed through equity. Company S is assessing a plan to buy a huge tract of land, which would be leased to the tenant farmers. This purchase is predicted to raise the annual earnings before tax in perpetuity. Person J is the new CFO (chief financial officer) of Company S, who has found the present capital cost of the company.

Person J felt that the company will be very valuable if it adds debt in its capital structure. While evaluating whether the company could issue debt to completely finance the project, she found that it can issue bonds at a par value with the coupon rate. She also found an optimal range of capital structure between 70% equity and 30% debt to maximize its value.

Characters in the case:

Company S

Company A

Person S

Person J

Adequate information:

If Company S moves beyond the 30% debt, the bonds issued by the company will have a lower rating and a greater coupon, which is the possibility of financial distress and the associated cost would increase.

Company S also has a corporate rate of tax.

d)

Expert Solution

Explanation of Solution

Given information: Company S has the outstanding stock of 9 million shares, while financed completely through equity. The present trade of the stock is $37.80 per share. The purchase price of the huge tract of land is $95 million. The expected increase in the earnings through the land purchase is $18.75 million.

The present capital cost of the company is 10.2%. The company will have an optimal capital structure if it is between 70% equity and 30% debt. The corporate rate of tax is 40%.

Formula to calculate the market value balance sheet:

Present value of the project=Increase in the yearly earnings of the firm Present capital cost

Calculate the market value balance sheet:

Present value of the project=Increase in the yearly earnings of the firm Present capital cost=$11,250,000$0.102=$110,294,118

Hence, the present value of the project is $110,294,118.

Balance sheet showing the market value after the land purchase has been made after the issue of stock:

Market Value Balance Sheet
Equity	$450,494,118	Old assets	$340,200,000
		PV of project	$110,294,118
Debt and equity	$450,494,118	Total assets	$450,494,118

Want to see more full solutions like this?

Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!

Answer 5

Chapter 16, Problem 3M

a)

Summary Introduction

To compute: The NPV (Net present value) of the project.

Case synopsis:

Company S is a real estate firm, whose CEO (chief executive officer) is Person R. The firm buys a real estate and rents it to the tenants. The firm gains profit every year. Before the foundation of Company S, Person R was the CEO and the founder of Company A, which is a farming operation. Company A was a failure firm, which ends up with bankruptcy. This situation made Person R to be extremely averse towards debt financing.

Hence, the company is completely financed through equity. Company S is assessing a plan to buy a huge tract of land, which would be leased to the tenant farmers. This purchase is predicted to raise the annual earnings before tax in perpetuity. Person J is the new CFO (chief financial officer) of Company S, who has found the present capital cost of the company.

Person J felt that the company will be very valuable if it adds debt in its capital structure. While evaluating whether the company could issue debt to completely finance the project, she found that it can issue bonds at a par value with the coupon rate. She also found an optimal range of capital structure between 70% equity and 30% debt to maximize its value.

Characters in the case:

Company S

Company A

Person S

Person J

Adequate information:

If Company S moves beyond the 30% debt, the bonds issued by the company will have a lower rating and a greater coupon, which is the possibility of financial distress and the associated cost would increase.

Company S also has a corporate rate of tax.

a)

Expert Solution

Answer to Problem 3M

The NPV of the project $15,294,118.

Explanation of Solution

Given information: Company S has the outstanding stock of 9 million shares, while financed completely through equity. The present trade of the stock is $37.80 per share. The purchase price of the huge tract of land is $95 million. The expected increase in the earnings through the land purchase is $18.75 million.

The present capital cost of the company is 10.2%. The company will have an optimal capital structure if it is between 70% equity and 30% debt. The corporate rate of tax is 40%.

Explanation:

The purchase of land will result with an increase in the earnings of the company by $18.75 million per year in perpetuity. Such earnings are taxed at 40%. Hence, after taxes, the land purchase will increase the yearly-expected earnings of the company.

Formula to calculate the increase in the earnings:

Earnings increase=Increase in purchase before tax(1−Rate of tax)

Calculate the increase in the earnings:

Earnings increase=Increase in purchase before tax(1−Rate of tax)=$18,750,000(1−0.40)=$11,250,000

Hence, the increase in the earnings after tax is $11,250,000.

As Company S is an all-equity company, the appropriate rate of discount is the company’s unlevered cost of equity. Hence, the NPV of the purchase is as follows:

Formula to calculate the NPV:

NPV=Increase in the earnings after-taxCurrent cost of capital−Initial cost

Calculate the NPV:

NPV=Increase in the earnings after-taxCurrent cost of capital−Initial cost=$11,250,0000.102−$95,000,000=$15,294,118

Hence, the NPV is $15,294,118.

b)

Summary Introduction

To construct: The balance sheet of Company S with its market value after its announcement that the company will use equity finance for the purchase, calculate the new price per share of the company’s stock and the number of shares required by the company to issue in order to finance the purchase.

The value of Company S will maximize by $15,294,118, which is NPV of the purchase, after the announcement. As per the efficient-market hypothesis, the firm’s market value will immediately increase to reflect the project’s NPV.

Case synopsis:

Company S is a real estate firm, whose CEO (chief executive officer) is Person R. The firm buys a real estate and rents it to the tenants. The firm gains profit every year. Before the foundation of Company S, Person R was the CEO and the founder of Company A, which is a farming operation. Company A was a failure firm, which ends up with bankruptcy. This situation made Person R to be extremely averse towards debt financing.

Hence, the company is completely financed through equity. Company S is assessing a plan to buy a huge tract of land, which would be leased to the tenant farmers. This purchase is predicted to raise the annual earnings before tax in perpetuity. Person J is the new CFO (chief financial officer) of Company S, who has found the present capital cost of the company.

Person J felt that the company will be very valuable if it adds debt in its capital structure. While evaluating whether the company could issue debt to completely finance the project, she found that it can issue bonds at a par value with the coupon rate. She also found an optimal range of capital structure between 70% equity and 30% debt to maximize its value.

Characters in the case:

Company S

Company A

Person S

Person J

Adequate information:

If Company S moves beyond the 30% debt, the bonds issued by the company will have a lower rating and a greater coupon, which is the possibility of financial distress and the associated cost would increase.

Company S also has a corporate rate of tax.

b)

Expert Solution

Answer to Problem 3M

The new price per share after the announcement of land purchase is $ 39.50 and the number of shares Company S needs to issue is $2,405,103.

Explanation of Solution

Given information:

Company S has the outstanding stock of 9 million shares, while financed completely through equity. The present trade of the stock is $37.80 per share. The purchase price of the huge tract of land is $95 million. The expected increase in the earnings through the land purchase is $18.75 million.

Explanation:

The market value equity of Company S after the purchase announcement is as follows:

The present capital cost of the company is 10.2%. The company will have an optimal capital structure if it is between 70% equity and 30% debt. The corporate rate of tax is 40%.

Formula to calculate the value of equity:

Equity value=Market value of equity+NPV

Calculate the value of equity:

Equity value=Market value of equity+NPV=$340,200,000+$15,294,118=$355,494,118

Hence, the equity value is $355,494,118.

Balance sheet showing the market value after its announcement of land purchase through equity finance:

Market value balance sheet
Equity	$355,494,118	Old assets	$340,200,000
		NPV of project	$15,294,118
Debt and equity	$355,494,118	Total assets	$355,494,118

As the market value of the company’s equity is $355,494,118 and the company has an outstanding stock of 9 million shares, the stock price of Company S after the announcement will be as follows:

Formula to calculate the new share price:

New share price=Market value of the firm's equityOutstanding shares

Calculate the new share price:

New share price=Market value of the firm's equityOutstanding shares=$355,494,118$9,000,000=$39.50

Hence, the new share price is $39.50.

Company S should increase $95 million to finance the purchase of land and the worth of the company’s stock is $39.50 per share. Hence, Company S must issue the amount as follows:

Formula to calculate the shares to be issued:

Shares to issue=Increase in the financing amount for land purchaseNew share price

Calculate the shares to be issued:

Shares to issue=Increase in the financing amount for land purchaseNew share price=$95,000,000$39.50=$2,405,103

Hence, the shares to be issued are $2,405,103.

c)

Summary Introduction

To construct: The balance sheet of Company S with its market value after the issue of equity prior to the purchase, calculate the new price per share of the company’s stock and the outstanding number of shares of the common stock that the company has owned.

Company S will receive a cash of $95 million due to equity issue. This will raise the assets and equity of the firm by $95 million. Hence, the balance sheet with the new market value after the issue of stock will be as follows:

Case synopsis:

Company S is a real estate firm, whose CEO (chief executive officer) is Person R. The firm buys a real estate and rents it to the tenants. The firm gains profit every year. Before the foundation of Company S, Person R was the CEO and the founder of Company A, which is a farming operation. Company A was a failure firm, which ends up with bankruptcy. This situation made Person R to be extremely averse towards debt financing.

Hence, the company is completely financed through equity. Company S is assessing a plan to buy a huge tract of land, which would be leased to the tenant farmers. This purchase is predicted to raise the annual earnings before tax in perpetuity. Person J is the new CFO (chief financial officer) of Company S, who has found the present capital cost of the company.

Person J felt that the company will be very valuable if it adds debt in its capital structure. While evaluating whether the company could issue debt to completely finance the project, she found that it can issue bonds at a par value with the coupon rate. She also found an optimal range of capital structure between 70% equity and 30% debt to maximize its value.

Characters in the case:

Company S

Company A

Person S

Person J

Adequate information:

If Company S moves beyond the 30% debt, the bonds issued by the company will have a lower rating and a greater coupon, which is the possibility of financial distress and the associated cost would increase.

Company S also has a corporate rate of tax.

c)

Expert Solution

Answer to Problem 3M

The outstanding number of shares of common stock that the company has is $11,405,103 and the price per share of the company’s stock is $39.50.

Explanation of Solution

Given information: Company S has the outstanding stock of 9 million shares, while financed completely through equity. The present trade of the stock is $37.80 per share. The purchase price of the huge tract of land is $95 million. The expected increase in the earnings through the land purchase is $18.75 million.

The present capital cost of the company is 10.2%. The company will have an optimal capital structure if it is between 70% equity and 30% debt. The corporate rate of tax is 40%.

Balance sheet showing the market value before the land purchase after the issue of stock:

Market Value Balance Sheet
Equity	$450,494,118	Cash	$95,000,000
		Old assets	$340,200,000
		NPV of project	$15,294,118
Debt and equity	$450,494,118	Total assets	$450,494,118

The stock price will remain unchanged. Hence, compute the total outstanding shares to show the constant stock price.

Formula to calculate the total outstanding shares:

Total shares outstanding=Outstanding shares+Number of shares to be issued

Calculate the total outstanding shares:

Total shares outstanding=Outstanding shares+Number of shares to be issued=$9,000,000+$2,405,103=$11,405,103

Hence, the total outstanding shares is $11,405,103.

Formula to calculate the share price:

Share price=EquityTotal shares outstanding

Calculate the share price:

Share price=EquityTotal shares outstanding=$450,494,118$11,405,103=$39.50

Hence, the share price is $39.50.

d)

Summary Introduction

To construct: The balance sheet of Company S after the purchase.

The project will increase by $18.75 million of extra pretax earnings per year forever. Such earnings will taxed at 40%. Hence, after taxes, the project will raise the yearly earnings of the firm by $11.25 million. Compute the present value of the increase in the earnings after-tax:

Case synopsis:

Company S is a real estate firm, whose CEO (chief executive officer) is Person R. The firm buys a real estate and rents it to the tenants. The firm gains profit every year. Before the foundation of Company S, Person R was the CEO and the founder of Company A, which is a farming operation. Company A was a failure firm, which ends up with bankruptcy. This situation made Person R to be extremely averse towards debt financing.

Hence, the company is completely financed through equity. Company S is assessing a plan to buy a huge tract of land, which would be leased to the tenant farmers. This purchase is predicted to raise the annual earnings before tax in perpetuity. Person J is the new CFO (chief financial officer) of Company S, who has found the present capital cost of the company.

Person J felt that the company will be very valuable if it adds debt in its capital structure. While evaluating whether the company could issue debt to completely finance the project, she found that it can issue bonds at a par value with the coupon rate. She also found an optimal range of capital structure between 70% equity and 30% debt to maximize its value.

Characters in the case:

Company S

Company A

Person S

Person J

Adequate information:

If Company S moves beyond the 30% debt, the bonds issued by the company will have a lower rating and a greater coupon, which is the possibility of financial distress and the associated cost would increase.

Company S also has a corporate rate of tax.

d)

Expert Solution

Explanation of Solution

Given information: Company S has the outstanding stock of 9 million shares, while financed completely through equity. The present trade of the stock is $37.80 per share. The purchase price of the huge tract of land is $95 million. The expected increase in the earnings through the land purchase is $18.75 million.

The present capital cost of the company is 10.2%. The company will have an optimal capital structure if it is between 70% equity and 30% debt. The corporate rate of tax is 40%.

Formula to calculate the market value balance sheet:

Present value of the project=Increase in the yearly earnings of the firm Present capital cost

Calculate the market value balance sheet:

Present value of the project=Increase in the yearly earnings of the firm Present capital cost=$11,250,000$0.102=$110,294,118

Hence, the present value of the project is $110,294,118.

Balance sheet showing the market value after the land purchase has been made after the issue of stock:

Market Value Balance Sheet
Equity	$450,494,118	Old assets	$340,200,000
		PV of project	$110,294,118
Debt and equity	$450,494,118	Total assets	$450,494,118

Answer 6

Chapter 16, Problem 3M

a)

Summary Introduction

To compute: The NPV (Net present value) of the project.

Case synopsis:

Company S is a real estate firm, whose CEO (chief executive officer) is Person R. The firm buys a real estate and rents it to the tenants. The firm gains profit every year. Before the foundation of Company S, Person R was the CEO and the founder of Company A, which is a farming operation. Company A was a failure firm, which ends up with bankruptcy. This situation made Person R to be extremely averse towards debt financing.

Hence, the company is completely financed through equity. Company S is assessing a plan to buy a huge tract of land, which would be leased to the tenant farmers. This purchase is predicted to raise the annual earnings before tax in perpetuity. Person J is the new CFO (chief financial officer) of Company S, who has found the present capital cost of the company.

Person J felt that the company will be very valuable if it adds debt in its capital structure. While evaluating whether the company could issue debt to completely finance the project, she found that it can issue bonds at a par value with the coupon rate. She also found an optimal range of capital structure between 70% equity and 30% debt to maximize its value.

Characters in the case:

Company S

Company A

Person S

Person J

Adequate information:

If Company S moves beyond the 30% debt, the bonds issued by the company will have a lower rating and a greater coupon, which is the possibility of financial distress and the associated cost would increase.

Company S also has a corporate rate of tax.

a)

Expert Solution

Answer to Problem 3M

The NPV of the project $15,294,118.

Explanation of Solution

Given information: Company S has the outstanding stock of 9 million shares, while financed completely through equity. The present trade of the stock is $37.80 per share. The purchase price of the huge tract of land is $95 million. The expected increase in the earnings through the land purchase is $18.75 million.

The present capital cost of the company is 10.2%. The company will have an optimal capital structure if it is between 70% equity and 30% debt. The corporate rate of tax is 40%.

Explanation:

The purchase of land will result with an increase in the earnings of the company by $18.75 million per year in perpetuity. Such earnings are taxed at 40%. Hence, after taxes, the land purchase will increase the yearly-expected earnings of the company.

Formula to calculate the increase in the earnings:

Earnings increase=Increase in purchase before tax(1−Rate of tax)

Calculate the increase in the earnings:

Earnings increase=Increase in purchase before tax(1−Rate of tax)=$18,750,000(1−0.40)=$11,250,000

Hence, the increase in the earnings after tax is $11,250,000.

As Company S is an all-equity company, the appropriate rate of discount is the company’s unlevered cost of equity. Hence, the NPV of the purchase is as follows:

Formula to calculate the NPV:

NPV=Increase in the earnings after-taxCurrent cost of capital−Initial cost

Calculate the NPV:

NPV=Increase in the earnings after-taxCurrent cost of capital−Initial cost=$11,250,0000.102−$95,000,000=$15,294,118

Hence, the NPV is $15,294,118.

Answer 7

Chapter 16, Problem 3M

a)

Summary Introduction

To compute: The NPV (Net present value) of the project.

Case synopsis:

Company S is a real estate firm, whose CEO (chief executive officer) is Person R. The firm buys a real estate and rents it to the tenants. The firm gains profit every year. Before the foundation of Company S, Person R was the CEO and the founder of Company A, which is a farming operation. Company A was a failure firm, which ends up with bankruptcy. This situation made Person R to be extremely averse towards debt financing.

Hence, the company is completely financed through equity. Company S is assessing a plan to buy a huge tract of land, which would be leased to the tenant farmers. This purchase is predicted to raise the annual earnings before tax in perpetuity. Person J is the new CFO (chief financial officer) of Company S, who has found the present capital cost of the company.

Person J felt that the company will be very valuable if it adds debt in its capital structure. While evaluating whether the company could issue debt to completely finance the project, she found that it can issue bonds at a par value with the coupon rate. She also found an optimal range of capital structure between 70% equity and 30% debt to maximize its value.

Characters in the case:

Company S

Company A

Person S

Person J

Adequate information:

If Company S moves beyond the 30% debt, the bonds issued by the company will have a lower rating and a greater coupon, which is the possibility of financial distress and the associated cost would increase.

Company S also has a corporate rate of tax.

Answer 8

a)

Expert Solution

Answer to Problem 3M

The NPV of the project $15,294,118.

Answer 9

a)

Expert Solution

Answer 10

a)

Expert Solution

Answer 11

Expert Solution

Answer 12

Explanation of Solution

Given information: Company S has the outstanding stock of 9 million shares, while financed completely through equity. The present trade of the stock is $37.80 per share. The purchase price of the huge tract of land is $95 million. The expected increase in the earnings through the land purchase is $18.75 million.

The present capital cost of the company is 10.2%. The company will have an optimal capital structure if it is between 70% equity and 30% debt. The corporate rate of tax is 40%.

Explanation:

The purchase of land will result with an increase in the earnings of the company by $18.75 million per year in perpetuity. Such earnings are taxed at 40%. Hence, after taxes, the land purchase will increase the yearly-expected earnings of the company.

Formula to calculate the increase in the earnings:

Earnings increase=Increase in purchase before tax(1−Rate of tax)

Calculate the increase in the earnings:

Earnings increase=Increase in purchase before tax(1−Rate of tax)=$18,750,000(1−0.40)=$11,250,000

Hence, the increase in the earnings after tax is $11,250,000.

As Company S is an all-equity company, the appropriate rate of discount is the company’s unlevered cost of equity. Hence, the NPV of the purchase is as follows:

Formula to calculate the NPV:

NPV=Increase in the earnings after-taxCurrent cost of capital−Initial cost

Calculate the NPV:

NPV=Increase in the earnings after-taxCurrent cost of capital−Initial cost=$11,250,0000.102−$95,000,000=$15,294,118

Hence, the NPV is $15,294,118.

Answer 13

b)

Summary Introduction

To construct: The balance sheet of Company S with its market value after its announcement that the company will use equity finance for the purchase, calculate the new price per share of the company’s stock and the number of shares required by the company to issue in order to finance the purchase.

The value of Company S will maximize by $15,294,118, which is NPV of the purchase, after the announcement. As per the efficient-market hypothesis, the firm’s market value will immediately increase to reflect the project’s NPV.

Case synopsis:

Company S is a real estate firm, whose CEO (chief executive officer) is Person R. The firm buys a real estate and rents it to the tenants. The firm gains profit every year. Before the foundation of Company S, Person R was the CEO and the founder of Company A, which is a farming operation. Company A was a failure firm, which ends up with bankruptcy. This situation made Person R to be extremely averse towards debt financing.

Hence, the company is completely financed through equity. Company S is assessing a plan to buy a huge tract of land, which would be leased to the tenant farmers. This purchase is predicted to raise the annual earnings before tax in perpetuity. Person J is the new CFO (chief financial officer) of Company S, who has found the present capital cost of the company.

Person J felt that the company will be very valuable if it adds debt in its capital structure. While evaluating whether the company could issue debt to completely finance the project, she found that it can issue bonds at a par value with the coupon rate. She also found an optimal range of capital structure between 70% equity and 30% debt to maximize its value.

Characters in the case:

Company S

Company A

Person S

Person J

Adequate information:

If Company S moves beyond the 30% debt, the bonds issued by the company will have a lower rating and a greater coupon, which is the possibility of financial distress and the associated cost would increase.

Company S also has a corporate rate of tax.

b)

Expert Solution

Answer to Problem 3M

The new price per share after the announcement of land purchase is $ 39.50 and the number of shares Company S needs to issue is $2,405,103.

Explanation of Solution

Given information:

Company S has the outstanding stock of 9 million shares, while financed completely through equity. The present trade of the stock is $37.80 per share. The purchase price of the huge tract of land is $95 million. The expected increase in the earnings through the land purchase is $18.75 million.

Explanation:

The market value equity of Company S after the purchase announcement is as follows:

The present capital cost of the company is 10.2%. The company will have an optimal capital structure if it is between 70% equity and 30% debt. The corporate rate of tax is 40%.

Formula to calculate the value of equity:

Equity value=Market value of equity+NPV

Calculate the value of equity:

Equity value=Market value of equity+NPV=$340,200,000+$15,294,118=$355,494,118

Hence, the equity value is $355,494,118.

Balance sheet showing the market value after its announcement of land purchase through equity finance:

Market value balance sheet
Equity	$355,494,118	Old assets	$340,200,000
		NPV of project	$15,294,118
Debt and equity	$355,494,118	Total assets	$355,494,118

As the market value of the company’s equity is $355,494,118 and the company has an outstanding stock of 9 million shares, the stock price of Company S after the announcement will be as follows:

Formula to calculate the new share price:

New share price=Market value of the firm's equityOutstanding shares

Calculate the new share price:

New share price=Market value of the firm's equityOutstanding shares=$355,494,118$9,000,000=$39.50

Hence, the new share price is $39.50.

Company S should increase $95 million to finance the purchase of land and the worth of the company’s stock is $39.50 per share. Hence, Company S must issue the amount as follows:

Formula to calculate the shares to be issued:

Shares to issue=Increase in the financing amount for land purchaseNew share price

Calculate the shares to be issued:

Shares to issue=Increase in the financing amount for land purchaseNew share price=$95,000,000$39.50=$2,405,103

Hence, the shares to be issued are $2,405,103.

Answer 14

b)

Summary Introduction

To construct: The balance sheet of Company S with its market value after its announcement that the company will use equity finance for the purchase, calculate the new price per share of the company’s stock and the number of shares required by the company to issue in order to finance the purchase.

The value of Company S will maximize by $15,294,118, which is NPV of the purchase, after the announcement. As per the efficient-market hypothesis, the firm’s market value will immediately increase to reflect the project’s NPV.

Case synopsis:

Company S is a real estate firm, whose CEO (chief executive officer) is Person R. The firm buys a real estate and rents it to the tenants. The firm gains profit every year. Before the foundation of Company S, Person R was the CEO and the founder of Company A, which is a farming operation. Company A was a failure firm, which ends up with bankruptcy. This situation made Person R to be extremely averse towards debt financing.

Hence, the company is completely financed through equity. Company S is assessing a plan to buy a huge tract of land, which would be leased to the tenant farmers. This purchase is predicted to raise the annual earnings before tax in perpetuity. Person J is the new CFO (chief financial officer) of Company S, who has found the present capital cost of the company.

Person J felt that the company will be very valuable if it adds debt in its capital structure. While evaluating whether the company could issue debt to completely finance the project, she found that it can issue bonds at a par value with the coupon rate. She also found an optimal range of capital structure between 70% equity and 30% debt to maximize its value.

Characters in the case:

Company S

Company A

Person S

Person J

Adequate information:

If Company S moves beyond the 30% debt, the bonds issued by the company will have a lower rating and a greater coupon, which is the possibility of financial distress and the associated cost would increase.

Company S also has a corporate rate of tax.

Answer 15

b)

Expert Solution

Answer to Problem 3M

The new price per share after the announcement of land purchase is $ 39.50 and the number of shares Company S needs to issue is $2,405,103.

Answer 16

b)

Expert Solution

Answer 17

b)

Expert Solution

Answer 18

Expert Solution

Answer 19

Explanation of Solution

Given information:

Company S has the outstanding stock of 9 million shares, while financed completely through equity. The present trade of the stock is $37.80 per share. The purchase price of the huge tract of land is $95 million. The expected increase in the earnings through the land purchase is $18.75 million.

Explanation:

The market value equity of Company S after the purchase announcement is as follows:

The present capital cost of the company is 10.2%. The company will have an optimal capital structure if it is between 70% equity and 30% debt. The corporate rate of tax is 40%.

Formula to calculate the value of equity:

Equity value=Market value of equity+NPV

Calculate the value of equity:

Equity value=Market value of equity+NPV=$340,200,000+$15,294,118=$355,494,118

Hence, the equity value is $355,494,118.

Balance sheet showing the market value after its announcement of land purchase through equity finance:

Market value balance sheet
Equity	$355,494,118	Old assets	$340,200,000
		NPV of project	$15,294,118
Debt and equity	$355,494,118	Total assets	$355,494,118

As the market value of the company’s equity is $355,494,118 and the company has an outstanding stock of 9 million shares, the stock price of Company S after the announcement will be as follows:

Formula to calculate the new share price:

New share price=Market value of the firm's equityOutstanding shares

Calculate the new share price:

New share price=Market value of the firm's equityOutstanding shares=$355,494,118$9,000,000=$39.50

Hence, the new share price is $39.50.

Company S should increase $95 million to finance the purchase of land and the worth of the company’s stock is $39.50 per share. Hence, Company S must issue the amount as follows:

Formula to calculate the shares to be issued:

Shares to issue=Increase in the financing amount for land purchaseNew share price

Calculate the shares to be issued:

Shares to issue=Increase in the financing amount for land purchaseNew share price=$95,000,000$39.50=$2,405,103

Hence, the shares to be issued are $2,405,103.

Answer 20

c)

Summary Introduction

To construct: The balance sheet of Company S with its market value after the issue of equity prior to the purchase, calculate the new price per share of the company’s stock and the outstanding number of shares of the common stock that the company has owned.

Company S will receive a cash of $95 million due to equity issue. This will raise the assets and equity of the firm by $95 million. Hence, the balance sheet with the new market value after the issue of stock will be as follows:

Case synopsis:

Company S is a real estate firm, whose CEO (chief executive officer) is Person R. The firm buys a real estate and rents it to the tenants. The firm gains profit every year. Before the foundation of Company S, Person R was the CEO and the founder of Company A, which is a farming operation. Company A was a failure firm, which ends up with bankruptcy. This situation made Person R to be extremely averse towards debt financing.

Hence, the company is completely financed through equity. Company S is assessing a plan to buy a huge tract of land, which would be leased to the tenant farmers. This purchase is predicted to raise the annual earnings before tax in perpetuity. Person J is the new CFO (chief financial officer) of Company S, who has found the present capital cost of the company.

Person J felt that the company will be very valuable if it adds debt in its capital structure. While evaluating whether the company could issue debt to completely finance the project, she found that it can issue bonds at a par value with the coupon rate. She also found an optimal range of capital structure between 70% equity and 30% debt to maximize its value.

Characters in the case:

Company S

Company A

Person S

Person J

Adequate information:

If Company S moves beyond the 30% debt, the bonds issued by the company will have a lower rating and a greater coupon, which is the possibility of financial distress and the associated cost would increase.

Company S also has a corporate rate of tax.

c)

Expert Solution

Answer to Problem 3M

The outstanding number of shares of common stock that the company has is $11,405,103 and the price per share of the company’s stock is $39.50.

Explanation of Solution

Given information: Company S has the outstanding stock of 9 million shares, while financed completely through equity. The present trade of the stock is $37.80 per share. The purchase price of the huge tract of land is $95 million. The expected increase in the earnings through the land purchase is $18.75 million.

The present capital cost of the company is 10.2%. The company will have an optimal capital structure if it is between 70% equity and 30% debt. The corporate rate of tax is 40%.

Balance sheet showing the market value before the land purchase after the issue of stock:

Market Value Balance Sheet
Equity	$450,494,118	Cash	$95,000,000
		Old assets	$340,200,000
		NPV of project	$15,294,118
Debt and equity	$450,494,118	Total assets	$450,494,118

The stock price will remain unchanged. Hence, compute the total outstanding shares to show the constant stock price.

Formula to calculate the total outstanding shares:

Total shares outstanding=Outstanding shares+Number of shares to be issued

Calculate the total outstanding shares:

Total shares outstanding=Outstanding shares+Number of shares to be issued=$9,000,000+$2,405,103=$11,405,103

Hence, the total outstanding shares is $11,405,103.

Formula to calculate the share price:

Share price=EquityTotal shares outstanding

Calculate the share price:

Share price=EquityTotal shares outstanding=$450,494,118$11,405,103=$39.50

Hence, the share price is $39.50.

Answer 21

c)

Summary Introduction

To construct: The balance sheet of Company S with its market value after the issue of equity prior to the purchase, calculate the new price per share of the company’s stock and the outstanding number of shares of the common stock that the company has owned.

Company S will receive a cash of $95 million due to equity issue. This will raise the assets and equity of the firm by $95 million. Hence, the balance sheet with the new market value after the issue of stock will be as follows:

Case synopsis:

Company S is a real estate firm, whose CEO (chief executive officer) is Person R. The firm buys a real estate and rents it to the tenants. The firm gains profit every year. Before the foundation of Company S, Person R was the CEO and the founder of Company A, which is a farming operation. Company A was a failure firm, which ends up with bankruptcy. This situation made Person R to be extremely averse towards debt financing.

Hence, the company is completely financed through equity. Company S is assessing a plan to buy a huge tract of land, which would be leased to the tenant farmers. This purchase is predicted to raise the annual earnings before tax in perpetuity. Person J is the new CFO (chief financial officer) of Company S, who has found the present capital cost of the company.

Person J felt that the company will be very valuable if it adds debt in its capital structure. While evaluating whether the company could issue debt to completely finance the project, she found that it can issue bonds at a par value with the coupon rate. She also found an optimal range of capital structure between 70% equity and 30% debt to maximize its value.

Characters in the case:

Company S

Company A

Person S

Person J

Adequate information:

If Company S moves beyond the 30% debt, the bonds issued by the company will have a lower rating and a greater coupon, which is the possibility of financial distress and the associated cost would increase.

Company S also has a corporate rate of tax.

Answer 22

c)

Expert Solution

Answer to Problem 3M

The outstanding number of shares of common stock that the company has is $11,405,103 and the price per share of the company’s stock is $39.50.

Answer 23

c)

Expert Solution

Answer 24

c)

Expert Solution

Answer 25

Expert Solution

Answer 26

Explanation of Solution

Given information: Company S has the outstanding stock of 9 million shares, while financed completely through equity. The present trade of the stock is $37.80 per share. The purchase price of the huge tract of land is $95 million. The expected increase in the earnings through the land purchase is $18.75 million.

The present capital cost of the company is 10.2%. The company will have an optimal capital structure if it is between 70% equity and 30% debt. The corporate rate of tax is 40%.

Balance sheet showing the market value before the land purchase after the issue of stock:

Market Value Balance Sheet
Equity	$450,494,118	Cash	$95,000,000
		Old assets	$340,200,000
		NPV of project	$15,294,118
Debt and equity	$450,494,118	Total assets	$450,494,118

The stock price will remain unchanged. Hence, compute the total outstanding shares to show the constant stock price.

Formula to calculate the total outstanding shares:

Total shares outstanding=Outstanding shares+Number of shares to be issued

Calculate the total outstanding shares:

Total shares outstanding=Outstanding shares+Number of shares to be issued=$9,000,000+$2,405,103=$11,405,103

Hence, the total outstanding shares is $11,405,103.

Formula to calculate the share price:

Share price=EquityTotal shares outstanding

Calculate the share price:

Share price=EquityTotal shares outstanding=$450,494,118$11,405,103=$39.50

Hence, the share price is $39.50.

Answer 27

d)

Summary Introduction

To construct: The balance sheet of Company S after the purchase.

The project will increase by $18.75 million of extra pretax earnings per year forever. Such earnings will taxed at 40%. Hence, after taxes, the project will raise the yearly earnings of the firm by $11.25 million. Compute the present value of the increase in the earnings after-tax:

Case synopsis:

Company S is a real estate firm, whose CEO (chief executive officer) is Person R. The firm buys a real estate and rents it to the tenants. The firm gains profit every year. Before the foundation of Company S, Person R was the CEO and the founder of Company A, which is a farming operation. Company A was a failure firm, which ends up with bankruptcy. This situation made Person R to be extremely averse towards debt financing.

Hence, the company is completely financed through equity. Company S is assessing a plan to buy a huge tract of land, which would be leased to the tenant farmers. This purchase is predicted to raise the annual earnings before tax in perpetuity. Person J is the new CFO (chief financial officer) of Company S, who has found the present capital cost of the company.

Person J felt that the company will be very valuable if it adds debt in its capital structure. While evaluating whether the company could issue debt to completely finance the project, she found that it can issue bonds at a par value with the coupon rate. She also found an optimal range of capital structure between 70% equity and 30% debt to maximize its value.

Characters in the case:

Company S

Company A

Person S

Person J

Adequate information:

If Company S moves beyond the 30% debt, the bonds issued by the company will have a lower rating and a greater coupon, which is the possibility of financial distress and the associated cost would increase.

Company S also has a corporate rate of tax.

d)

Expert Solution

Explanation of Solution

Given information: Company S has the outstanding stock of 9 million shares, while financed completely through equity. The present trade of the stock is $37.80 per share. The purchase price of the huge tract of land is $95 million. The expected increase in the earnings through the land purchase is $18.75 million.

The present capital cost of the company is 10.2%. The company will have an optimal capital structure if it is between 70% equity and 30% debt. The corporate rate of tax is 40%.

Formula to calculate the market value balance sheet:

Present value of the project=Increase in the yearly earnings of the firm Present capital cost

Calculate the market value balance sheet:

Present value of the project=Increase in the yearly earnings of the firm Present capital cost=$11,250,000$0.102=$110,294,118

Hence, the present value of the project is $110,294,118.

Balance sheet showing the market value after the land purchase has been made after the issue of stock:

Market Value Balance Sheet
Equity	$450,494,118	Old assets	$340,200,000
		PV of project	$110,294,118
Debt and equity	$450,494,118	Total assets	$450,494,118

Answer 28

d)

Summary Introduction

To construct: The balance sheet of Company S after the purchase.

The project will increase by $18.75 million of extra pretax earnings per year forever. Such earnings will taxed at 40%. Hence, after taxes, the project will raise the yearly earnings of the firm by $11.25 million. Compute the present value of the increase in the earnings after-tax:

Case synopsis:

Company S is a real estate firm, whose CEO (chief executive officer) is Person R. The firm buys a real estate and rents it to the tenants. The firm gains profit every year. Before the foundation of Company S, Person R was the CEO and the founder of Company A, which is a farming operation. Company A was a failure firm, which ends up with bankruptcy. This situation made Person R to be extremely averse towards debt financing.

Hence, the company is completely financed through equity. Company S is assessing a plan to buy a huge tract of land, which would be leased to the tenant farmers. This purchase is predicted to raise the annual earnings before tax in perpetuity. Person J is the new CFO (chief financial officer) of Company S, who has found the present capital cost of the company.

Person J felt that the company will be very valuable if it adds debt in its capital structure. While evaluating whether the company could issue debt to completely finance the project, she found that it can issue bonds at a par value with the coupon rate. She also found an optimal range of capital structure between 70% equity and 30% debt to maximize its value.

Characters in the case:

Company S

Company A

Person S

Person J

Adequate information:

If Company S moves beyond the 30% debt, the bonds issued by the company will have a lower rating and a greater coupon, which is the possibility of financial distress and the associated cost would increase.

Company S also has a corporate rate of tax.

Answer 29

d)

Expert Solution

Explanation of Solution

Given information: Company S has the outstanding stock of 9 million shares, while financed completely through equity. The present trade of the stock is $37.80 per share. The purchase price of the huge tract of land is $95 million. The expected increase in the earnings through the land purchase is $18.75 million.

The present capital cost of the company is 10.2%. The company will have an optimal capital structure if it is between 70% equity and 30% debt. The corporate rate of tax is 40%.

Formula to calculate the market value balance sheet:

Present value of the project=Increase in the yearly earnings of the firm Present capital cost

Calculate the market value balance sheet:

Present value of the project=Increase in the yearly earnings of the firm Present capital cost=$11,250,000$0.102=$110,294,118