Construct the Market Value Balance Sheet
XYZ, Inc., another company founded by Larry Davidson in 2005, is currently entirely equity financed. That means the company carries no debt in its capital structure. It has only 25 million shares of common stock outstanding. The stock is selling at $38 per share. WR is considering purchasing a huge modern rental shopping complex located at downtown Indianapolis, Indiana, to lease to some well-known high-end retail stores such as Nordstrom, Von Maur, Lord & Taylor, Macy's and Dillard's. The offer price for this shopping complex is $620 million. This project is expected to increase WR's annual pretax earnings by $328 million and the same amount of annual pretax earnings increase will occur forever into the future. WR's current cost of capital is 14 percent. According to the investment banks in Indiana, WR can issue bonds at par value with a 7 percent coupon rate and the optimal capital structure for WR is 60 percent equity and 40 percent debt. If WR uses more than 40 percent debt, the cost of debt to the firm will increase significantly. WR pays 35 percent corporate taxes (including both state and federal). Your company has just been hired by Larry as a financial consultant. You are expected to look for the answers to all of the key questions, as stated below, that might be brought up for discussion in their next board meeting.
1. If WR would like to maximize its total market value, should it issue debt or equity to pay for the rental shopping complex? Briefly explain.
2. How does the market value balance sheet of WR look like before the firm makes the announcement on the rental project? Explain and construct the market value balance sheet
3. What is the present value of the rental project, assuming that WR issues equity (i.e. stock) to finance it?
4. How will WR's market value balance sheet look like after the firm makes announcement on the rental project which will be financed by equity? Explain and construct the market value balance sheet.
5. If WR decides to issue equity to fund the purchase of the rental shopping complex,
(A) what will be the price per share of the firm's stock?
(b) how many shares will wr need to issue?
(c) how will the firm's market value balance sheet look like after the equity issue but before the purchase of the rental shopping complex has been made? Explain and construct the market value balance sheet.
(d) how many shares of common stock will be outstanding after the equity issue?
(e) what is the new price per share of the firm's stock?
(f) how will the firm's market value balance sheet look like after purchasing the rental shopping complex? Explain and construct the market value balance sheet.
6. If WR decides to issue debt (i.e. borrow money by selling the 7 percent bonds) to pay for the rental shopping complex,
(a) what will be the market value of the firm?
(b) how will the firm's market value balance sheet look like after both the debt issue and the purchase of the rental shopping complex? Explain and construct the market value balance sheet.
(c) what will the price per share of the firm's stock be after both the debt issue and the rental shopping complex purchase?
7. Which method of financing (equity versus debt) maximizes the per-share stock price of WR's equity?