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 $ 74

Number of shares 40,000

Total assets $ 8,200,000

Total liabilities $ 4,000,000

Net income $ 700,000

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

. a. 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.)

b. 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.)

c. 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., .1616.)

d. What is the NPV of this investment? (A negative answer 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.)

a. Current book value per share =

New book value per share =

b. Current EPS =

New EPS =

c. Current market-to-book ratio =

New market-to-book ratio =

d. NPV =

Does accounting dilution occur here? Yes No

Does market value dilution occur here? Yes No

Answer 1

The total equity of the company is total assets minus total liabilities, or:

Equity = $8,200,000 – 4,000,000

Equity = $4,200,000

The current ROE of the company = NI/Total Equity

= 700,000/4,200,000 = 0.1667= 16.67%

The New Net Income = ROE*( Total equity + invesntment)

= 1/6*(4,200,000 + 800,000) = 833,333.33

The current earnings per share = 700,000/40,000 = $17.5

The new shares to be issued are = 800,000/74 = 10,810.81 = 10,811 Shares

Total number of shares = 40,000 +10,811 = 50,811

New earnings per share = 833,333.33/50,811 = $16.40

The current P/E ratio = 74/17.5 = 4.22857

If the PE remains constant new price = 4.22857 *16.40 = $69.35

a).
Current Book Value per share = 4,200,000/40,000 =$105

New book value per share = (4,200,000 + 833,333.33)/50,811 = $99.06

b).

From the calculations, Current EPS = $17.50

NEPS = $16.40

c).

Current market to book = 74/105 = 0.7

New Market to book = 69.35/99.06 = 0.7

d).

The NPV of the project is the cost of the project plus the new market value of the firm minus thecurrent market value of the firm

NPV = -800,000 + (69.35*50,811 -74*40000) = -236,257.15 (Negative)

*Does accounting dilution occur here?
Yes, Accouting diution has taken place since market to book ratio is less than one.

*Does market value dilution occur here?

Yes, Market value dilution also takes place.