Stephenson Real Estate is looking to purchase a tract of land for $60 million. They are considering financing the purchase through either issuing new equity or taking on new debt. Issuing equity would increase the number of outstanding shares but keep the capital structure all-equity. Taking on debt would introduce a tax shield from the interest payments but increase financial risk. Based on calculations, financing with debt maximizes the post-financing stock price per share at $37.06 compared to $35.86 per share with equity financing. Therefore, the method of financing that maximizes Stephenson's per-share stock price is financing the land purchase through issuing new corporate bonds and taking on debt.

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. 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. 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. 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. 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. Debt vs Equity Financing
60 million Land Purchase
Maximize Stephenson Real Estate total
market value
EquityDebt

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. 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. 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. Question 2
Construct Stephenson’s market value balance
sheet before it announces the purchase.

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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. Question 5
Which method of financing maximizes
the per-share stock price of
Stephenson’s equity?

25. Debt vs Equity

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. 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. 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. Thank You