The Metallica Heavy Metal Mining (MHMM) Corporation wants to diversify its opera
ID: 451031 • 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 $800,000, and it will be financed with a new equity issue. The return on the investment will equal MHMM’s current ROE.
What is the current book value per share? The new book value per share? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
What is the current market-to-book ratio? The new market-to-book ratio? (Do not round intermediate calculations and round your answers to 4 decimal places, e.g., 32.1616.)
What is the current EPS? The new EPS? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
What is the NPV of this investment? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answer to the nearest whole dollar amount, e.g., 32.)
Does accounting dilution occur here?
The Metallica Heavy Metal Mining (MHMM) Corporation wants to diversify its operations. Some recent financial information for the company is shown here:
Explanation / Answer
Answer:
The total equity of the company is total assets minus total liabilities, or:
Equity = $7,600,000 – 2,200,000
Equity =$5,400,000
So, the current ROE of the company is:
ROE 0 = NI 0 /TE 0 = $440,000 / $5,400,000 = 0.08148 or 8.148%
The new net income will be the ROE times the new total equity, or:
NI 1 = (ROE 0 )(TE 1 ) = 0.08148($5,400,000 + 800,000) = $505,176
The company’s current earnings per share are:
EPS 0 = NI 0 /Shares outstanding 0 = $440,000/40,000 shares = $11.00
The number of shares the company will offer is the cost of the investment divided by the current share price, so: Number of new shares = $800,000/$73 = 10,958.9
The earnings per share after the stock offer will be:
EPS 1 = $505,176/50,958.9 shares = $9.913
The current P/E ratio is: (P/E) 0 = $73/$11.00 = 6.636
Assuming the P/E remains constant, the new stock price will be:
P 1 = 6.636($9.913) = $65.78
The current book value per share and the new book value per share are:
BVPS 0 = TE 0 /shares 0 = ($5,400,000)/40,000 shares = $135 per share
BVPS 1 = TE 1 /shares 1 = ($5,400,000 + 891,000)/50,958.9 shares = $123.452 per share
So the current and new market-to-book ratios are:
Market-to-book 0 = $73/$135 = 0.54
Market-to-book 1 = $65.78/$123.452 = 0.532
The NPV of the project is the cost of the project plus the new market value of the firm minus the current market value of the firm, or:
NPV = –$800,000 + [$65.78(50,958.9) – $73(40,000)] = $-367,923.558
Accounting dilution takes place here because the market-to-book ratio is less than one. Market value dilution has occurred since the firm is investing in a negative NPV project.