Essentials of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
9th Edition
ISBN: 9781259277214
Author: Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Bradford D Jordan Professor
Publisher: McGraw-Hill Education
expand_more
expand_more
format_list_bulleted
Question
Chapter 13, Problem 5CC
Summary Introduction
Case synopsis:
Company S is a real estate firm, whose CEO (chief executive officer) is Person R. The firm buys real estate and rents it to tenants. The firm has profit for each year. Before the foundation of Company S, Person R was the founder and CEO of Company A, which is a farming operation. Company A was a failure firm, which ended 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 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 coupon rate. She found an optimal range of capital structure between 70% equity and 30% debt.
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 as the possibility of financial distress and the associated cost increases.
- Company S also has a corporate rate of tax.
To discuss: The method of financing that would increase the per-share stock price of the equity of Company S.
Expert Solution & Answer
Want to see the full answer?
Check out a sample textbook solution
Students have asked these similar questions
Stephenson Real Estate Company was founded 25 years ago by the current CEO, Robert Stephenson.The company purchases real estate, including land and buildings, and rents the property totenants. The company has shown a profit every year for the past 18 years, and the shareholdersare satisfied with the company’s management. Prior to founding Stephenson Real Estate, Robertwas the founder and CEO of a failed alpaca-farming operation. The resulting bankruptcy madehim extremely averse to debt financing. As a result, the company is entirely equity financed, with12 million shares of common stock outstanding. The stock currently trades at $48.50 per share.Robert is evaluating a plan to purchase a huge tract of land in eastern Canada for $45 million.The land will subsequently be leased to tenant farmers. This purchase is expected to increase Stephenson’sannual pre-tax earnings by $11 million in perpetuity. Kim Weyand, the company’s newCFO, has been put in charge of the project. Kim has determined…
Stephenson Real Estate Company was founded 25 years ago by the current CEO, Robert Stephenson.The company purchases real estate, including land and buildings, and rents the property totenants. The company has shown a profit every year for the past 18 years, and the shareholdersare satisfied with the company’s management. Prior to founding Stephenson Real Estate, Robertwas the founder and CEO of a failed alpaca-farming operation. The resulting bankruptcy madehim extremely averse to debt financing. As a result, the company is entirely equity financed, with12 million shares of common stock outstanding. The stock currently trades at $48.50 per share.Robert is evaluating a plan to purchase a huge tract of land in eastern Canada for $45 million.The land will subsequently be leased to tenant farmers. This purchase is expected to increase Stephenson’sannual pre-tax earnings by $11 million in perpetuity. Kim Weyand, the company’s newCFO, has been put in charge of the project. Kim has determined…
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…
Chapter 13 Solutions
Essentials of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
Ch. 13.1 - What is the relationship between the WACC and the...Ch. 13.1 - Prob. 13.1BCQCh. 13.2 - Prob. 13.2ACQCh. 13.2 - Prob. 13.2BCQCh. 13.2 - Prob. 13.2CCQCh. 13.3 - What does MM Proposition I state?Ch. 13.3 - Prob. 13.3BCQCh. 13.3 - Prob. 13.3CCQCh. 13.4 - Prob. 13.4ACQCh. 13.4 - Prob. 13.4BCQ
Ch. 13.5 - Prob. 13.5ACQCh. 13.5 - Prob. 13.5BCQCh. 13.6 - Can you describe the tradeoff that defines the...Ch. 13.6 - What are the important factors in making capital...Ch. 13.7 - Prob. 13.7ACQCh. 13.7 - Prob. 13.7BCQCh. 13.8 - What is the APR (in connection with bankruptcy...Ch. 13.8 - What is the difference between liquidation and...Ch. 13 - Prob. 13.3CCh. 13 - Prob. 13.4CCh. 13 - Prob. 13.5CCh. 13 - Section 13.6The static theory of capital structure...Ch. 13 - Prob. 13.7CCh. 13 - Business Risk versus Financial Risk. Explain what...Ch. 13 - Prob. 2CTCRCh. 13 - Prob. 3CTCRCh. 13 - Prob. 4CTCRCh. 13 - Prob. 5CTCRCh. 13 - Prob. 6CTCRCh. 13 - Prob. 7CTCRCh. 13 - Prob. 8CTCRCh. 13 - Prob. 9CTCRCh. 13 - Prob. 10CTCRCh. 13 - EBIT and Leverage. Kaelea, Inc., has no debt...Ch. 13 - EBIT, Taxes, and Leverage. Repeat parts (a) and...Ch. 13 - Prob. 3QPCh. 13 - Break-Even EBIT. Kyle Corporation is comparing two...Ch. 13 - Prob. 5QPCh. 13 - Prob. 6QPCh. 13 - Prob. 7QPCh. 13 - Prob. 8QPCh. 13 - Homemade Leverage. Lydie Enterprises is...Ch. 13 - Calculating WACC. Crosby Industries has a...Ch. 13 - Calculating WACC. Malkin Corp. has no debt but can...Ch. 13 - Prob. 12QPCh. 13 - Prob. 13QPCh. 13 - Prob. 14QPCh. 13 - MM. In the previous question, what is the...Ch. 13 - Prob. 16QPCh. 13 - Prob. 17QPCh. 13 - Prob. 18QPCh. 13 - Prob. 19QPCh. 13 - Business and Financial Risk. Assume a firms debt...Ch. 13 - Prob. 1CCCh. 13 - Prob. 2CCCh. 13 - Stephenson Real Estate Recapitalization Stephenson...Ch. 13 - Prob. 4CCCh. 13 - Prob. 5CC
Knowledge Booster
Similar questions
- Robin Smith is considering buying shares in Mah Company. The company has reported an increase in net income this year. On careful reading of the notes to the financial statements, Robin learns that the company had a LIFO liquidation this year. Robin understands what caused the liquidation but has asked you for advice about how to interpret it. Required: 2. Could a LIFO liquidation profit create ethical issues?arrow_forwardPenco Ltd’s board of directors are looking into expanding the company’s business operations. Before investing in a new product, the board conducted one focus group, and based on this one bit of feedback, invested $5m of company funds to develop the product. Within two years, the company had lost $8m due to poor sales. Shareholders are furious and wish to hold directors personally liable for this loss. Analyse the likely outcome for directors if shareholders were to accuse the board of breaching CA s 180.arrow_forwardTerence Breezeway, the CEO of Prairie Home Stores, wondered what retirement would be like. It was almost 20 years to the day since his uncle Jacob Breezeway, Prairie Home's founder, had asked him to take responsibility for managing the company. Now it was time to spend more time riding and fishing on the cld Lazy Beta Ranch. U'nder Mr. Breezeway's leadership, Prairie Home had grown slowty but steadily and was solidly profitable. (E Table 7.6 shows earnings. dividends, and book asset values for the last 5 years.) Most of the company's supermarkets had been modernized, and its brand name was well known. Table 7.6 Financial data for Prairie Home Stores, 2019-2023 (figures in millions) 2019 2020 2021 2022 2023 Book value, start of year $62.7 $73.9 $66.1 $69.0 $76.5 Earnings 9.7 9.5 11.8 11.0 11.2 Dividends 6.3 6.6 6.9 7.4 7.7 Retained earnings 3.4 2.9 4.9 2.6 3.5 Book value, end of year 66.1 69.0 73.9 76.5 80.0 Note 1. Prairie Home Stores has 400,000 common shar 2. The company's poley ia…arrow_forward
- 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.…arrow_forwardTom purchased the following assets for use in his business during the current year: Date Asset Cost 12 - Jan Car 24,000 4 - Feb Equipment 36,000 15 - Mar Qualified leasehold improvement 40,000 24 - Apr Computers 10, 000 Total 110, 000 Tom has $50,000 in profits before depreciation expense and has no other sources of income. Tom does not expect to purchase any new assets next year and hopes to grow sales, but who knows for sure? Give Tom two options as to how to depreciate the assets for tax. Select one option to recommend and justify your answer.arrow_forwardYou manage a real estate investment company. One year ago, the company purchased 10 parcels of land distributed throughout the community for $12.0 million each. A recent appraisal of the properties indicates that five of the parcels are now worth $9.8 million each, while the other five are worth $18.0 million each. Ignoring any income received from the properties and any taxes paid over the year, calculate the investment company's accounting earnings and its economic earnings in each of the following cases: a. The company sells all of the properties at their appraised values today. b. The company sells none of the properties. c. The company sells the properties that have fallen in value and keeps the others. d. The company sells the properties that have risen in value and keeps the others. Note: Negative amounts should be indicated by parentheses. Enter your answers in millions. Accounting Economic Income (million) Income (million) Case a. b. $ 0 C. d.arrow_forward
- Tom purchased the following assets for use in his business during the current year: Date Asset Cost 12-Jan Car 24,000 4-Feb Equipment 36,000 15-Mar Qualified leasehold improvement 40,000 24-Apr Computers 10,000 Total 110,000 Tom has $50,000 in profits before depreciation expense and has no other sources of income. Tom does not expect to purchase any new assets next year and hopes to grow sales, but who knows for sure? Give Tom two options as to how to depreciate the assets for tax. Select one option to recommend and justify your answer.arrow_forwardFamily Resorts, Inc., is a holding company for severalvacation hotels in the northeastern and mid-Atlantic states. The firm originally purchased severalold inns, restored the buildings, and upgraded therecreational facilities. Vacationing families havebeen well pleased with the inns because many servicesare provided that accommodate children andafford parents time for themselves. Since the completionof the restoration 10 years ago, the company hasbeen profitable.Family Resorts has just concluded its annualmeeting of regional and district managers. Thismeeting is held each November to review the resultsof the previous season and to help the managers preparefor the upcoming year. Before the meeting, themanagers submitted proposed budgets for their districtsor regions, as appropriate. These budgets arereviewed and consolidated into an annual operatingbudget for the entire company. The 2015 budget hasbeen presented at the meeting, and the managersaccepted it.To evaluate the performance of…arrow_forwardDEF Company owns several businesses. The trade wars have caused a general slowdown in business and DEF has decided to downsize. DEF intends to sell its nursery and garden business for $700,000 and has approached XYZ Company as a potential buyer. XYZ is hesitant about purchasing the business as it is not confident about making the business succeed. To sweeten the deal DEF agrees to buy back the business for $400,000 in 3 years’ time if XYZ wants to give up the business then. The details relating to the project are as follows: •Cost of nursery and garden business is $700,000 No additional working capital is needed •Staff costs are $200,000 per year•Rental of land is $120,000 per year •Projected sales each year is $500,000 •Variable costs (plants, gardening tools, etc.) are 10% of sales •DEF offers buy back the business for $400,000 after 3 years if XYZ does not want to continue with the business XYZ intends to fund part of its purchase of the business using borrowing. It also intends to…arrow_forward
- DEF Company owns several businesses. The trade wars have caused a general slowdown in business and DEF has decided to downsize. DEF intends to sell its nursery and garden business for $700,000 and has approached XYZ Company as a potential buyer. XYZ is hesitant about purchasing the business as it is not confident about making the business succeed. To sweeten the deal DEF agrees to buy back the business for $400,000 in 3 years’ time if XYZ wants to give up the business then. The details relating to the project are as follows: •Cost of nursery and garden business is $700,000 No additional working capital is needed •Staff costs are $200,000 per year•Rental of land is $120,000 per year •Projected sales each year is $500,000 •Variable costs (plants, gardening tools, etc.) are 10% of sales •DEF offers buy back the business for $400,000 after 3 years if XYZ does not want to continue with the business XYZ intends to fund part of its purchase of the business using borrowing. It also intends to…arrow_forwardJoe Laramie owns and operates Joe's Burgers, a small fast food store, located at the edge of CityCollege Newton, Ohio. After several very profitable years, Joe's Burgers began to have problems. Most of the pro related to Joe's expansion of the eating area in the restaurant without corresponding increases in the food area. Joe does not have the cash or financial backing to expand further. He has therefore decided to sell William Sheets is interested in purchasing the husinorr Hounuarrow_forwardAmy and Jevin Mounty own a textile design business in Beau Bassin. They bought a new computer which cost $4000 on 1 January 2020. The depreciation charge for the computer was 40% per annum using reducing balance method. Because of rapid developments in technology, the computer was out of date by end of 2021. Amy decided to sell the computer and was offered $600 which she accepted. The computer was sold on 31 December 2021. The financial year for the business runs from 1 January to 31 December.a. Calculate the accumulated depreciation charge and the net book value of the computer at the end of 2020 and 2021. b. Calculate the profit or loss on disposal of the computer.c. Show the Computer account and the Provision for depreciation Account for the year ended 31 December 2020. d. List down all the journal entries for the disposal of the computer.arrow_forward
arrow_back_ios
SEE MORE QUESTIONS
arrow_forward_ios
Recommended textbooks for you
Financial Accounting: The Impact on Decision Make...AccountingISBN:9781305654174Author:Gary A. Porter, Curtis L. NortonPublisher:Cengage Learning
Intermediate Financial Management (MindTap Course...FinanceISBN:9781337395083Author:Eugene F. Brigham, Phillip R. DavesPublisher:Cengage Learning
Financial Accounting: The Impact on Decision Make...
Accounting
ISBN:9781305654174
Author:Gary A. Porter, Curtis L. Norton
Publisher:Cengage Learning
Intermediate Financial Management (MindTap Course...
Finance
ISBN:9781337395083
Author:Eugene F. Brigham, Phillip R. Daves
Publisher:Cengage Learning