The Metallica Heavy Metal Mining (MHMM) Corporation wants to diversify its opera
ID: 2735271 • 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: Stock price $ 50 Number of shares 30,000 Total assets $ 8,700,000 Total liabilities $ 3,600,000 Net income $ 600,000 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 $________________
Explanation / Answer
Equity of the Company = Total Assets - Total Liabilities
= 87,00,000 - 36,00 ,000 = $ 51,00,000
So the current ROE of the Company is :-
ROE 0 = Net Income 0 / Total Equity 0
= $ 6,00,000 / $ 51 ,00,000 = .1176 or 11.76 %
The New Net Income will be the ROE times the new Total Equity , or
Net Income 1 = ROE 0 * Total Equity 1
= 0.1176 ( 51,00,000 + 6,40,000) = $ 675024
The Company's Current EPS are :
EPS 0 = Net Income 0 / Shares Outstanding = 6,00,000 / 30,000 = $ 20
Now,
The Number of shares that company will offer = cost of the investment / current share price
= 6,40,000 / $ 50
Number of new shares = 12800 shares
The EPS after the stock offer will be = 675024 / 30000 + 12800 shares
= $ 15.77
Current P/E Ratio = $ 50 / $ 20 = 2.50
Assuming that PE Ratio remains constant , the new stock price will be
P1 = $ 15.77 (2.50 ) = $ 39.43
The current Book Value per share and the new book value per share are :
BVPS 0 = TE 0 / Shares 0 = Total Assetss- Total Liabilities / 30000 shares
= 87,00,000 - 36,00 ,000 / 30000 shares = $ 170 per share
BVPS 1 = TE 1 / Shares 1 =( 87,00,000 - 36,00 ,000 + 640000 ) / 30000 +12800 = $ 134.11 per share
So the current and new market book to ratios are :
Market to book 0 = $ 50 / 170 = 0.2941
Market to book 1 = $ 39.43 / 134.11 = 0.2940
NPV of the project = cost of the project + new market value of the firm - Current market value of the firm
= - 640000 + ( 39.43 * 42800 - $ 50 * 30000)
= - 640000 + ( 1687604 - 1500000)
= - 640000 + 187604 = $ - 452396