Would you recommend that it issue debt or equity

Reference no: EM133322689

Question: Ariff real estate company was founded 10 years ago by the current CEO, Ariff. The company purchases real estate including land and buildings and rents the property to tenants. The company has shown a profit every year for the past 10 years and the shareholders are satisfied with the company's management. Prior to founding Ariff real estate, Ariff was the founder and CEO of a failed alfafa farming operation. The resulting bankruptcy made Ariff extremely afraid to use debt financing. As a result, the company is entirely relying on equity financing with 10 million shares of common stock outstanding. The stock currently trades at RM 23.45 per share.

Ariff is evaluating a plan to purchase two acres of land in Perak for RM1,000,000. The land will subsequently be leased to tenant farmers. This purchase is expected to increase Ariff's annual pretax earnings by RM15 million in perpetuity. Alex, the company's new CFO, has been put in charge of the project. Alex has determined that the company's current cost of capital is 10.5%. He feels that the company would be more valuable if it included debt in its capital structure, so he is evaluating whether the company should issue debt to entirely finance the project. Based on some conversation with investment banks, he thinks that the company can issue bond at par value with a 9% coupon rate. From his analysis, he also believes that a capital structure in the range of 60 percent equity/40 percent debt would be optimal. If the company goes beyond 40 percent debt, its bond will carry a lower rating and a much higher coupon because the possibility of financial distress and the associated costs would rise sharply. Ariff has a 35 percent corporate tax rate.

a) If Ariff wishes to maximize its total market value, would you recommend that it issue debt or equity to finance the land purchase? Explain.

b) Which method of financing will maximize the per-share stock price of Ariff's equity?

Reference no: EM133322689

Questions Cloud

Analyze the civil rights movement of the 1950s and 1960 : Analyze the Civil Rights Movement of the 1950s and 1960s. What progress did the movement make in the U.S. Supreme Court?

Will you recommend patricia to invest in the project : will you recommend Patricia to invest in the project or to go back to the casino? Do you considerfour years a correct period to analyze this project

What are your reasons for supporting this policy : What are your reasons for supporting this policy? Your job is to convince the public that this is a necessary and useful policy.

Writing on sop what is an sop : writing SOP. What is an SOP? In the workplace we use all types of standards or guidelines in how to complete job. An SOP is the "Standard Operating Procedure

Would you recommend that it issue debt or equity : If Ariff wishes to maximize its total market value, would you recommend that it issue debt or equity to finance the land purchase? Explain

Which form of business organization would be appropriate : Which form of business organization would be most appropriate? What are the chief characteristics, advantages, and disadvantages of this form of business

Explain has sweet air violated the civil rights act : compared with only one-fourth of those in the minority groups. Sweet Air has an all-white cleaning crew. Has Sweet Air violated the Civil Rights Act? Explain.

Consider the following hypothetical situation : Consider the following hypothetical situation. You are an advisor to Quantum Go (QG), a onetime startup company founded by UConn graduates that is now a public

How could we prevent such an economic crisis : What lessons could be learned from such an episode? ...from an international finance perspective and How could we prevent such an economic crisis

User Account

All Pages