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.

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.)

Current book value $                    per share

per share New book value $ per share

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.)

Current market-to-book

New market-to-book

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.)

Current earnings per share $

New earnings per share $

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.)

NPV $

Does accounting dilution occur here?

Yes

No

Does market value dilution occur here?

No

Yes

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

Question 1:

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

Question 2:

Current market to book = 74/105 = 0.7

New Market to book = 69.35/99.06 = 0.7

Question 3:

From the calculations, Current earnings per share = $17.50

New earnings per share = $16.40

Question 4:

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)

Yes, Accouting diution has taken place since market to book ratio is less than one

Yes, Market value dilution also takes place