The Metallica Heavy Metal Mining (MHMM) Corporation wants to diversify its opera

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 $750,000, 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.)

  Stock price $ 68   Number of shares 30,000   Total assets $ 8,000,000   Total liabilities $ 3,500,000   Net income $ 360,000

Explanation / Answer

Solution.

1.

Total equity of company = Total asset - Total libility

= 8,000,000 - 3,500,000 = 4,500,000

ROE = Net Income / Total Equity

= 360,000 / 4,500,000 = 8%

The new net income will be the ROE times the new total equity, or:

NI 1 = (ROE 0 )(TE 1 ) = 0.08 ($4,500,000 + 750,000) = $420,000

The company’s current earnings per share are:

EPS 0 = NI 0 /Shares outstanding 0 = 360,000 / 30,000 shares = $12.00

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 = $750,000 / $68 = 11,029

3. The earnings per share after the stock offer will be:

EPS 1 = $420,000 / 41,029 shares = $10.24

The current P/E ratio is:

(P/E) 0 = $68 / $12.00 = 5.666

2. Assuming the P/E remains constant, the new stock price will be:

P 1 = 5.666 ($10.24) = $58.01

The current book value per share and the new book value per share are:

BVPS 0 = TE 0 /shares 0 = ( 8,000,000 - 3,500,000 ) /30,000 shares = $150 per share

BVPS 1 = TE 1 /shares 1 = ( 8,000,000 - 3,500,000 + 750,000) / 41,029 shares = $127.95 per share

2. The current and new market-to-book ratios are:

Market-to-book 0 = $68 / $150 = 0.4533

Market-to-book 1 = $58.01 / $127.95 = 0.4533

4. NPV of this investment

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.

NPV = -$750,000 + [ $58.01 ( 41,029) - $68 ( 30,000 )

= -$409,907.71

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