Case3 Finance Real
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Transcript of Case3 Finance Real
![Page 1: Case3 Finance Real](https://reader036.fdocuments.in/reader036/viewer/2022082712/563dbb93550346aa9aae625b/html5/thumbnails/1.jpg)
1) Hosier Rentals in considering purchasing a new apartment complex for 25 million. To fund this purchase with its total market value in mind, Hosier Rentals should consider using debt to fund this project. Debt, unlike equity, creates a tax shield of interest expenses that leads to a higher value of the firm because interest expenses reduce the taxable income of the firm.
2) Hosier Rentals is currently an all-equity firm with 300,000 outstanding shares of stock at $80 per share. Therefore, the current market value of equity is,
Market Value of Equity = 300,000 * 80 = 24,000,000
Then the Balance Sheet would look like,
Hosier Rentals
Market Value Balance Sheet- Before Complex Purchase
Assets 24,000,000 Equity 24,000,000
Total Assets 24,000,000 Total Debt and Equity 24,000,000
3) The project will generate an additional annual pretax earnings of $9,600,000 which will be taxed at 35%. Therefore,
Hosier after taxes increase in earnings = $9,600,000 * (1-0.35) = $6,240,000.
Because the firm is all-equity, the discount rate for its expected cash flows is the unlevered cost of equity, or 15%. Then the present value of the project is,
Present Value of Project = $6,240,000/.15
= $41,600,000
Finally, the NPV of the entire project can be given by,
Net Present Value of Project = -$25,000,000 + $41,600,000
= $16,600,000
4) With the announcement of the purchase of the new complex, the firms market value increased immediately by the net present value of the project. Therefore, the new balance sheet looks like,
![Page 2: Case3 Finance Real](https://reader036.fdocuments.in/reader036/viewer/2022082712/563dbb93550346aa9aae625b/html5/thumbnails/2.jpg)
Hosier Rentals
Market Value Balance Sheet- After Project Announcement
Assets 24,000,000NPV of Project 16,600,000 Equity
40,600,000
Total Assets 40,600,000 Total Debt and Equity 40,600,000
5)a. We can see from the new balance sheet that the firm’s equity is $40,600,000 and we
know that the firm currently had 300,000 shares of common stock outstanding. Therefore, the stock price immediately after announcement is given by,
New Share Price = $40,600,000/300,000 = $135.33
b. Hosier needs to raise 25,000,000 for the funding of the project, so with a share price seen in the previous question, we can determine how many shares they need to issue by the following,
Shares to Issue = $25,000,000/$135.33 = 184,733 shares
c.
Hosier Rentals
Market Value Balance Sheet- After Stock Issue
Assets 24,000,000
Cash 25,000,000
NPV of Project 16,600,000 Equity 65,600,000
Total Assets 65,600,000 Total Debt and Equity 65,600,000
d. The total number of total shares outstanding now is,
Total Shares Outstanding = 300,000+184,733 = 484,733 Shares
e. The new price per share is given by,
New share price = $65,600,000/484,733
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= $135.33
f. Hoiser will then use the 25,000,000 to purchase the complex and thus its cash balance is reduced by that amount. After the payment is made, the value of the project to the firm will be equal to the PV of the project. Therefore,
Hosier Rentals
Market Value Balance Sheet- After the Purchase
Assets 24,000,000
PV of Project 41,600,000 Equity 65,600,000
Total Assets 65,600,000 Total Debt and Equity 65,600,000
6)a. We know by the Modigliani-Miller Proposition that in a world with corporate taxes, the
value of a levered firm is equal to the value of the unlevered firm plus the present value of the interest tax shield. We have the value of the firm if the project is funded by just equity, so we can calculate the value of the firm if it purchases the complex with debt by,
V_L = $65,600,000 + 0.35($25,000,000)
= $74,350,000
b. According to the Efficient Market Hypothesis, when the complex is purchased with debt the value of the Hoiser will increase by the present value of the interest tax shield, which is,
Tax shield = 0.35($25,000,000)
=$8,750,000
Therefore, the balance sheet would look like,
Hosier Rentals
Market Value Balance Sheet- After Purchase with Debt
Value Unlevered $65,600,000 Debt $25,000,000
Tax Shield 8,750,000 Equity $49,350,000
Total Assets $74,350,000 Total Debt and Equity $74,350,000
![Page 4: Case3 Finance Real](https://reader036.fdocuments.in/reader036/viewer/2022082712/563dbb93550346aa9aae625b/html5/thumbnails/4.jpg)
c. After borrowing the money and purchasing the complex, the total number of outstanding shares remain constant. Therefore, the new price per share is given by,
New share price = $49,350,000/300,000
= $164.50
7) In summary, if Hoiser uses just equity to finance the purchase of the new complex, or it remains an unlevered firm, its stock price will remain at $135.33 per share. If they issue debt to fund the purchase of the complex, or they turn themselves into an unlevered firm, their stock price will raise to $164.50. We can see that there is an increase of $29.17 in the price of their stock. Therefore, to maximize the per share price of their stock, they should issue the debt to fund this project.