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Solution

Option -1 Company Issues Debt 30% and Equity 70%

Current Value of the company = 20 million shares @$ 35.50 = $710 million

Cost of land = $60 million


Pre tax earning will increase by $ 14 million in perpetuity
Cost of capital = 12.5%
Issue of Bond at 8% coupon rate.
Tax rate = 40%
Company issue 30 % debt and 70 % equity to purchase the land.
Assume bond has a par value of $1000
Amount of debt = (60 million * 30 %) = $18 Million
Amount of Equity = ( 60 million * 70% ) = $42 Million
Therefore number of bond required to be issued = ($18 million / 1000) = 18000 Bonds.
Coupon on the bonds = (18000*8%*1000) = $ 1.44 millions.
Share price = $35.50
Number of shares reqquired to be issued = ($ 42 million /35.50) = 1.183 million (approximately).
Therefore total number of shares = (20 million + 1.183 million )= 21.183 million shares.

Pr
Less : Coupons on Bonds( Sh
Profit aft
less :
Pro

Therefore profit will i

Note : Price / earning ratio (P/E) = ( 1/cos

Earnin

Therefore share price = (P/E


S
Therefore value of th

Note: If we don’t assume the P/E ratio then the ALTERNATIVE solution would

Value of the company prior to acq


Less :
Add: increase in profit (Calcula

Option -2 Company Issues Debt 100 % .

Current Value of the company = 20 million shares @$ 35.50 = $710 million

Cost of land = $60 million


Pre tax earning will increase by $ 14 million in perpetuity
Cost of capital = 12.5%
Issue of Bond at 8% coupon rate.
Tax rate = 40%
Company issue debt to purchase the land.
Assume bond has a par value of $1000

Therefore number of bond required to be issued = ($60 million / 1000) = 60000 Bonds.
Coupon on the bonds = (60000*8%*1000) = $ 4.8 millions.

Pr
Less : Coupons on Bonds( Sh
Profit aft
less :
Pro

Therefore profit will i

Value of the company prior to acq


Less :
Add: increase in profit (Calcula
Option -3 Company Issues Equity 100 % .

Current Value of the company = 20 million shares @$ 35.50 = $710 million

Cost of land = $60 million


Pre tax earning will increase by $ 14 million in perpetuity
Cost of capital = 12.5%
Tax rate = 40%
Company issue Equity to purchase the land.
Current share price = $ 35.50
Therefore number of Shares required to be issued = ($60 million / $35.50) = 1.690 Million shares (approximately)
Total number of shares = (20 million + 1.69 ) = 21.69 million.

Pr
less :
Pro

Therefore profit will i

Value of the company prior to acq


Less :
Add: increase in profit (Calcula

Therefore the company should issue equity to purchase land.


Amount in Million
(in $)

14
1.44
12.56
5.024
7.536

A/i
Profit
cost of capital

($7.536 / 12.5%)
$60.288 Million

(1/ 12.5%)
8

Profit after tax / Number of


share
( $60.288 / 21.183)
$2.8461 per share

(8*2.8461)
$ 22.77
21.183 million share * 22.77
$482.34 million

$710 Million
($60 Million)
$ 60.288 Million
$ 710.288 Million

Amount in Million
(in $)

14
4.8
9.2
3.68
5.52

A/i
Profit
cost of capital

($ 5.52 / 12.5%)
$44.16 Million

$710 Million
($60 Million)
$ 44.16 Million
$ 694.16 Million

Amount in Million
(in $)

14
5.6
8.4

A/i
Profit
cost of capital

($ 8.40 / 12.5%)
$67.20 Million

$710 Million
($60 Million)
$ 67.20 Million
$ 717.20 Million