The Metallica Heavy Metal Mining (MHMM) Corporation wants to diversify its opera
ID: 2734226 • Letter: T
Question
The Metallica Heavy Metal Mining (MHMM) Corporation wants to diversify its operations. Some recent financial information for the company is shown here:
MHMM is considering an investment that has the same PE ratio as the firm. The cost of the investment is $640,000, and it will be financed with a new equity issue. (Do not round intermediate calculations.)
The ROE on the investment would have to be percent ?? (Round your answer to 2 decimal places (e.g., 32.16).) if we wanted the price after the offering to be $50 per share (assume the PE ratio remains constant), and the NPV of the investment would be $ ?? (Leave no cells blank - be certain to enter "0" wherever required.). Accounting dilution does occur in this case. Market value dilution does not occur in this case.
The Metallica Heavy Metal Mining (MHMM) Corporation wants to diversify its operations. Some recent financial information for the company is shown here:
Explanation / Answer
Return on equity(ROE) = Net income / Total equity
Total Equity = Total assets - Total Liabilities =6100000-3800000 =$2300000
Given Net income =$450000
ROE = 450000 / 2300000 = 19.565%
Cost of investment is increased by issued by equity of $640000
New total equity =$2300000+$640000 =$2940000
Net income after equityinvestment = ROE *Total equity after equity investment
=19.565%*2940000=$575211
Current earning per share (EPS) = Net income / shares outstanding =450000 / 25000 =$18
No of New shares = new investmnet by equity / share price=640000/50 =12800 shares
EPS after stock offer = Net income after equity investment / shares outstanding
=575211/(25000+12800) =$15.217
P/E ratio(before equity investment) = Share price /EPS =50/18=2.778
New stock price(P/E ratio remains constant) =P/E * EPS afte stock offer =2.778*15.217 = $42.273
Net present value = cost of project + (New market price -Current market price)
Current Book value per share = total equity / shares outstanding = 2300000 / 25000 =$92
New Book value per share = Total equity /Shares outstanding = $2940000 /(25000+12800) =$77.778
Current Market to book value =Stock price/Current book value = 25/92 =0.272
New Market to Book value = New stock price / New book value =42.273/77.778=0.544
Net present value = (cost of project) + (New market price -Current market price)
=-640000+(42.273*37800-50*25000) =-640000+(1597919.4-1250000) =-292080.6
Accounting dilution occurs in this case because market to book value is less than one.
Since firm is having investing in NPV with negative value,it can be said that Market dilution occured.