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	$	79
Number of shares		20,000
Total assets	$	8,400,000
Total liabilities	$	2,800,000
Net income	$	420,000

The company is considering an investment that has the same PE ratio as the firm. The cost of the investment is $600,000, and it will be financed with a new equity issue. The return on the investment will equal the company's current ROE.

What is the current book value per share and the book value per share with the investment? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

	Book value per share
Current		$
New		$

What is the current market-to-book ratio and the market-to-book ratio with the investment? (Do not round intermediate calculations and round your answers to 4 decimal places, e.g., 32.1616.)

	Market-To-Book
Current
New

What is the current EPS and the EPS with the investment? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

	Earnings per share
Current	$
New	$

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.)

NPV           $

Does accounting dilution occur here?

Yes

No

Does market value dilution occur here?

No

Yes

Answer 1

1)
Equity = Assets - Liabilities = $8400000 - $2800000	$5,600,000
1)   Current Book Value per Share = (Assets - Liabilities)/ Outstanding Shares
Current Book Value Per Share = 5,600,000/20,000 shares	$280	Per Share
New Book Value Per Share = 5600000+600000/20,000 + 7595 shares (calculated below)	$224.68	Per Share
Number of shares issued = $600,000/$79	7595	Shares
2)
Current market-to-book ratio = $79/$280	0.2821
New market-to-book ratio = $74.43/$224.68	0.2821
Current EPS = Net Income/Shares Outstanding = $420,000/20,000 shares	$21	Per Share
New EPS = $465,000/20,000 + 7595 (calculated below)	$16.85	Per Share
P/E ratio = $79/21	$3.76
New Market value = P/E ratio x New EPs = 3.04 x 24.5	$63.39
ROE = NI/ Equity = $420,000/$5,600,000	7.50%
ROE is equal to ROI
New Total Equity = $5,600,000 + $600,000	$6,200,000
New Net Income = $6,200,000 x 7.50%	$465,000
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 = -$600,000 +[(63.39 x 27595)-($79 x 20000)]	-$430,714.29
Accounting dilution takes place here because the market-to-book ratio is less than one	Yes
Market value dilution has occurred since the firm is investing in a negative NPV project	Yes