Ohiannye Real Estate Recapitalization
Ohiannye Real Estate Company was founded 25 years ago by the current CEO, Robert Ohiannye.
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 18 years, and the shareholders are satisfied
with the company’s management. Prior to founding Ohiannye Real Estate, Robert was the founder
and CEO of a failed alpaca farming operation. The resulting bankruptcy made him extremely
averse to debt financing. As a result, the company is entirely equity financed, with 15 million
shares of common stock outstanding. The stock currently trades at GHS 35.20 per share.
Ohiannye is evaluating a plan to purchase a huge tract of land in the southeastern United States for
GHS 110 million. The land will subsequently be leased to tenant farmers. This purchase is
expected to increase Ohiannye’s annual pretax earnings by GHS 27 million in perpetuity. Jennifer
Fasikabra, the company’s new CFO, has been put in charge of the project. Jennifer has determined
that the company’s current cost of capital is 12.5 percent. She feels that the company would be
more valuable if it included debt in its capital structure, so she is evaluating whether the company should issue the debt to entirely finance the project. Based on some conversations with investment
banks, she thinks that the company can issue bonds at par value with an 8 percent coupon rate.
From her analysis, she also believes that a capital structure in the range of 70 percent equity/30
percent debt would be optimal. If the company goes beyond 30 percent debt, its bonds will carry
a lower rating and a much higher coupon because the possibility of financial distress and the
associated costs would rise sharply. Ohiannye has a 40 percent corporate tax rate (state and
federal).
QUESTIONS:
1. If Ohiannye wishes to maximize its total market value, would you recommend that it
issue debt or equity to finance the land purchase? Explain.
2. Construct Ohiannye’s market value balance sheet before it announces the purchase.
3. Suppose Ohiannye decides to issue equity to finance the purchase.
a. What is the net present value of the project?
b. Construct Ohiannye’s market value balance sheet after it announces that the firm
will finance the purchase using equity. What would be the new price per share of
the firm’s stock? How many shares will Ohiannye need to issue to finance the
purchase?
c. Construct Ohiannye’s market value balance sheet after the equity issue but before
the purchase has been made. How many shares of common stock does Ohiannye
have outstanding? What is the price per share of the firm’s stock?
d. Construct Ohiannye’s market value balance sheet after the purchase has been
made.
4. Suppose Ohiannye decides to issue debt to finance the purchase.
a. What will the market value of the Ohiannye be if the purchase is financed with
debt?
b. Construct Ohiannye’s market value balance sheet after both the debt issue and the
land purchase. What is the price per share of the firm’s stock?
5. Which method of financing maximizes the per-share stock price of Ohiannye’s equity?
Ohiannye Real Estate Recapitalization
Ohiannye Real Estate Company was founded 25 years ago by the current CEO, Robert Ohiannye.
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 18 years, and the shareholders are satisfied
with the company’s management. Prior to founding Ohiannye Real Estate, Robert was the founder
and CEO of a failed alpaca farming operation. The resulting bankruptcy made him extremely
averse to debt financing. As a result, the company is entirely equity financed, with 15 million
shares of common stock outstanding. The stock currently trades at GHS 35.20 per share.
Ohiannye is evaluating a plan to purchase a huge tract of land in the southeastern United States for
GHS 110 million. The land will subsequently be leased to tenant farmers. This purchase is
expected to increase Ohiannye’s annual pretax earnings by GHS 27 million in perpetuity. Jennifer
Fasikabra, the company’s new CFO, has been put in charge of the project. Jennifer has determined
that the company’s current cost of capital is 12.5 percent. She feels that the company would be
more valuable if it included debt in its capital structure, so she is evaluating whether the company should issue the debt to entirely finance the project. Based on some conversations with investment
banks, she thinks that the company can issue bonds at par value with an 8 percent coupon rate.
From her analysis, she also believes that a capital structure in the range of 70 percent equity/30
percent debt would be optimal. If the company goes beyond 30 percent debt, its bonds will carry
a lower rating and a much higher coupon because the possibility of financial distress and the
associated costs would rise sharply. Ohiannye has a 40 percent corporate tax rate (state and
federal).
QUESTIONS:
1. If Ohiannye wishes to maximize its total market value, would you recommend that it
issue debt or equity to finance the land purchase? Explain.
2. Construct Ohiannye’s market value balance sheet before it announces the purchase.
3. Suppose Ohiannye decides to issue equity to finance the purchase.
a. What is the net present value of the project?
b. Construct Ohiannye’s market value balance sheet after it announces that the firm
will finance the purchase using equity. What would be the new price per share of
the firm’s stock? How many shares will Ohiannye need to issue to finance the
purchase?
c. Construct Ohiannye’s market value balance sheet after the equity issue but before
the purchase has been made. How many shares of common stock does Ohiannye
have outstanding? What is the price per share of the firm’s stock?
d. Construct Ohiannye’s market value balance sheet after the purchase has been
made.
4. Suppose Ohiannye decides to issue debt to finance the purchase.
a. What will the market value of the Ohiannye be if the purchase is financed with
debt?
b. Construct Ohiannye’s market value balance sheet after both the debt issue and the
land purchase. What is the price per share of the firm’s stock?
5. Which method of financing maximizes the per-share stock price of Ohiannye’s equity?
Related questions
| Tapley Inc. currently has total capital equal to $10 million, has zero debt, is in the 40% federal-plus-state tax bracket, has a net income of $4 million, and pays out 40% of its earnings as dividends. Net income is expected to grow at a constant rate of 5% per year, 240,000 shares of stock are outstanding, and the current WACC is 12.20%. The company is considering a recapitalization where it will issue $5 million in debt and use the proceeds to repurchase stock. Investment bankers have estimated that if the company goes through with the recapitalization, its before-tax cost of debt will be 11% and its cost of equity will rise to 15.5%. What is the stock's current price per share (before the recapitalization)? Round your answer to the nearest cent. Assuming that the company maintains the same payout ratio, what will be its stock price following the recapitalization? Assume that shares are repurchased at the price calculated in Part a. Round your answer to the nearest cent. Do not round intermediate steps. |
