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Stephenson Real Estate
Recapitalization
Corporate Finance Case Study
Shahin Firouztash 1111200071
Jevgenijs Lesevs 1111200...
Introduction (Shahin)
STEPHENSON Real Estate
Founded 25 years ago by current CEO, Robert Stephenson
Purchase real state, b...
Case Overview
Purchase track of land in of
land in the southeastern
USA for USD 60 million
Lease it for the
tenant farmers...
Case Overview
Based of my
conversations with
investment banks
We should issue
bonds with 8%
coupon rate
Based on my analys...
Question 1
If Setephenson wishes to maximize its total market
value, would you recommend that it issue debt or equity
to f...
Debt vs Equity Financing
60 million Land Purchase
Maximize Stephenson Real Estate total
market value
EquityDebt
Equity Financing
Advantages
 You can use your cash and that of your investors when
you start up (no large loan payments)
...
Debt Financing
Advantages
 Allows you to have control of your own destiny
 The lender(s) from whom you borrow money do n...
Question 1 Answer
Stephenson should use debt to finance the $60
million purchase!
1. interest payments are tax deductible
...
Question 2
Construct Stephenson’s market value balance
sheet before it announces the purchase.
Question 2
Since Stephenson is an all-equity firm with 20 million shares of
common stock outstanding, worth $35.50 per sha...
Question 3a & 3b
Suppose Stephenson decides to issue equity to
finance the purchase.
a. What is the net present value of t...
NPV of the Project
 Initial Outlay = $60,000,000
 Annual pretax earnings = $14,000,000
 Earnings after tax = $14,000,00...
Upon Announcement of Equity Issue to New Project
Stephenson Real Estate
Balance Sheet
(Upon Announcement of Equity Issue t...
Question 3c & 3d
c. Construct Stephenson’s market value balance sheet
after the equity issue but before the purchase has
b...
NPV of the project = $ 0
Share price = 710.000.000/20.000.000 = $35.5 per share
Number of shares = 60.000.000 / 35.5 = 1.6...
Upon Issuance of Equity, before Purchase
Stephenson Real Estate
Balance Sheet
(Upon Issuance of Equity, before Purchase)
C...
Upon Completion of Purchase
Stephenson Real Estate
Balance Sheet
(Upon Completion of Purchase)
Old Asset (20m x $35.50)= $...
Question 4
Suppose Stephenson decides to issue debt to
finance the purchase.
a. What will the market value of the Stephens...
Tax Shield
The reduction in income taxes that results from
taking an allowable deduction from taxable income
Exp of Non Ta...
Capital Structure under Corporate Tax
Equity
Tax
Unlevered Firm
Equity
Debt
Tax
Levered Firm
The levered firm pay less tax...
Financing by Debt
𝑽 𝑳 = 𝑽 𝑼 + 𝒕 𝒄 B
Modigliani-Miller Proposition I
in a world with corporate taxes
𝑽 𝑳 = $777,200,000 + ....
Balance Sheet & Stock Price
Stock price = Value of Equity / Number of Shares Outstanding
Stock price = $741,200,000 / 20,0...
Question 5
Which method of financing maximizes
the per-share stock price of
Stephenson’s equity?
Debt vs Equity
Equity Financing (review)
Advantages
 You can use your cash and that of your investors when
you start up (no large loan p...
Debt Financing (review)
Advantages
 Allows you to have control of your own destiny
 The lender(s) from whom you borrow m...
Calculation on Price per Share
Equity Capital
New share price =
$717,200,000 / 20,000,000
New share price = $35.86
Debt ...
Thank You
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Debt or equity financing

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Debt or equity financing

  1. 1. Stephenson Real Estate Recapitalization Corporate Finance Case Study Shahin Firouztash 1111200071 Jevgenijs Lesevs 1111200131 Khatereh Azarnoor 1101600315 Yoong Khai Hung 1111200139 Aliakbar Bahrpeyma1091200261 Uun Ainurrofiq 1111200141 Poon Wai Chuen 1111200122
  2. 2. Introduction (Shahin) STEPHENSON Real Estate Founded 25 years ago by current CEO, Robert Stephenson Purchase real state, building and rents property to tenants. Has shown profit for the last 18 years The company has 20 million shares outstanding Last traded price was USD 35.50 per share The company has virtually no debt The current cost of capital of the company is 12.5% The company is subject to 40% corporation tax rate Case Overview
  3. 3. Case Overview Purchase track of land in of land in the southeastern USA for USD 60 million Lease it for the tenant farmers Increases the earnings by USD 14 million on pre-tax basis He was the founder and CEO of a failed alpaca farming operation. The resulting bankruptcy made him extremely averse to debt financing!!! Robert, CEO Planning for a new project!
  4. 4. Case Overview Based of my conversations with investment banks We should issue bonds with 8% coupon rate Based on my analysis Capital structure of 70% of equity and 30% of debt is the most profitable for the company Kim, The new CFO “I think it would be more valuable if we include debt in company’s capital structure , so we should finance this project using debt structure…” If 30% dept: • much higher coupon rate • bonds would carry a lower rate • financial distress and associated costs
  5. 5. Question 1 If Setephenson wishes to maximize its total market value, would you recommend that it issue debt or equity to finance the land purchase? Explain.
  6. 6. Debt vs Equity Financing 60 million Land Purchase Maximize Stephenson Real Estate total market value EquityDebt
  7. 7. Equity Financing Advantages  You can use your cash and that of your investors when you start up (no large loan payments)  If business fails you don’t need to return money to investors.  Investors may offer valuable business assistance that you may not have. Disadvantages  investors own a piece of your business  you are expected to act in investors best interests
  8. 8. Debt Financing Advantages  Allows you to have control of your own destiny  The lender(s) from whom you borrow money do not share in your profits  You can apply for a loan that has more favorable terms.  If you finance your business using debt, the interest you repay on your loan is tax-deductible. Disadvantages  Large loan payments  Credit rating can be spoiled
  9. 9. Question 1 Answer Stephenson should use debt to finance the $60 million purchase! 1. interest payments are tax deductible 2. debt in capital structure will decrease the firm’s taxable income 3. It creates a tax shield that will increase the overall value of the firm.
  10. 10. Question 2 Construct Stephenson’s market value balance sheet before it announces the purchase.
  11. 11. Question 2 Since Stephenson is an all-equity firm with 20 million shares of common stock outstanding, worth $35.50 per share, the market value of the firm is: Market value of equity = $35.50 x 20,000,000 Market value of equity = $710,000,000
  12. 12. Question 3a & 3b Suppose Stephenson decides to issue equity to finance the purchase. a. What is the net present value of the project? b. Construct Stephenson’s market value balance sheet after it announces that the firm will finance the purchase with equity. What would be the new price per share of the firm’s stock? How many shares will Stephenson need to issue?
  13. 13. NPV of the Project  Initial Outlay = $60,000,000  Annual pretax earnings = $14,000,000  Earnings after tax = $14,000,000 x (1-0.40) = $ 8,400,000  NPV(project) = -$60,000,000 + ($8,400,000/0.125) = $7,200,000
  14. 14. Upon Announcement of Equity Issue to New Project Stephenson Real Estate Balance Sheet (Upon Announcement of Equity Issue to New Project) Old Asset (20m x $35.50)= $710,000,000 NPV of plant $ 7,200,000 Equity $717,200,000 Total Asset $717,200,000 New Price per share= $717,200,000 / 20,000,000 shares = $35.86 per share Number of shares to issue to finance the purchase = $60,000,000 / $35.86 = 1,673,173 shares The Price is Risen to reflect the news concerning the new project
  15. 15. Question 3c & 3d c. Construct Stephenson’s market value balance sheet after the equity issue but before the purchase has been made. How many shares of common stock does Stephenson have outstanding? What is the price per share of the firm’s stock? d. Construct Stephenson’s market value balance sheet after the purchase has been made !
  16. 16. NPV of the project = $ 0 Share price = 710.000.000/20.000.000 = $35.5 per share Number of shares = 60.000.000 / 35.5 = 1.690.140 Total number of share out standing = 21.690.140 Equity = 710.000.000 +60.000.000 = $770.000.000 NPV of the project = $ 7.200.00 Share price = 717.200.000/20.000.000 = $35.86 per share Number of shares = 60.000.000 / 38.86 = 1.673.173 Total number of share out standing = 21.673.173 Equity = 717.200.000 +60.000.000 = $777.200.000 Non-profitable project: Profitable project:
  17. 17. Upon Issuance of Equity, before Purchase Stephenson Real Estate Balance Sheet (Upon Issuance of Equity, before Purchase) Cash = $ 60,000,000 Old Asset (20m x $35.50)= $710,000,000 NPV of plant $ 7,200,000 Equity $777,200,000 Total Asset $777,200,000
  18. 18. Upon Completion of Purchase Stephenson Real Estate Balance Sheet (Upon Completion of Purchase) Old Asset (20m x $35.50)= $710,000,000 PV of project $ 67,200,000 Equity $777,200,000 Total Asset $777,200,000 PV Project = $8,400,000 / .125 PV Project = $67,200,000
  19. 19. Question 4 Suppose Stephenson decides to issue debt to finance the purchase. a. What will the market value of the Stephenson company? b. Construct Stephenson’s market value balance sheet after both the debt issue and the land purchase. What is the price per share of the firm stock?
  20. 20. Tax Shield The reduction in income taxes that results from taking an allowable deduction from taxable income Exp of Non Taxable Income : • debt interest • mortgage interest, • medical expenses, • charitable donations, • amortization • and depreciation.
  21. 21. Capital Structure under Corporate Tax Equity Tax Unlevered Firm Equity Debt Tax Levered Firm The levered firm pay less taxes because debt interest is non taxable income. Thus the sum of the debt + equity of levered firm is greater than the unlevered (all equity) firm
  22. 22. Financing by Debt 𝑽 𝑳 = 𝑽 𝑼 + 𝒕 𝒄 B Modigliani-Miller Proposition I in a world with corporate taxes 𝑽 𝑳 = $777,200,000 + .40 ( $60,000,000 ) 𝑽 𝑳 = $801,200,000 𝑽 𝑳 = Present Value of Levered Firm 𝑽 𝑼 = Present Value of Unlevered Firm 𝒕 𝒄 = Corporate Tax Rate B = Amount of Debt from the previous calculation, 𝑽 𝑼 = $777,200,000
  23. 23. Balance Sheet & Stock Price Stock price = Value of Equity / Number of Shares Outstanding Stock price = $741,200,000 / 20,000,000 Stock price = $37.06
  24. 24. Question 5 Which method of financing maximizes the per-share stock price of Stephenson’s equity?
  25. 25. Debt vs Equity
  26. 26. Equity Financing (review) Advantages  You can use your cash and that of your investors when you start up (no large loan payments)  If business fails you don’t need to return money to investors.  Investors may offer valuable business assistance that you may not have. Disadvantages  investors own a piece of your business  you are expected to act in investors best interests
  27. 27. Debt Financing (review) Advantages  Allows you to have control of your own destiny  The lender(s) from whom you borrow money do not share in your profits  You can apply for a loan that has more favorable terms.  If you finance your business using debt, the interest you repay on your loan is tax-deductible. Disadvantages  Large loan payments  Credit rating can be spoiled
  28. 28. Calculation on Price per Share Equity Capital New share price = $717,200,000 / 20,000,000 New share price = $35.86 Debt Capital Stock price = $741,200,000 / 20,000,000 Stock price = $37.06
  29. 29. Thank You

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