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	$	67
Number of shares		35,000
Total assets	$	8,100,000
Total liabilities	$	4,900,000
Net income	$	750,000

MHMM is considering an investment that has the same PE ratio as the firm. The cost of the investment is $850,000, and it will be financed with a new equity issue. The return on the investment will equal MHMM’s current ROE.

  

What is the new price per share if the investment is made? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

  

New price

$

What will happen to the 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
New book value	$  per share

What will happen to the 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 will happen to the 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? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

NPV

$

Does accounting dilution occur here?

Yes No

Does market value dilution occur here?

No Yes

Answer 1

Total equity = Assests-Liablities= 8,100,000- 4900000=32,00,000

ROE= NI/TE=750,000/32,00,000= 0.2343

The new new income= 0.2343*(32,00,000+850,000) = 94,89,15

Current EPS = NI/shares outstanding = 750,000/35000= $21.43

The number of shares the company will offer is the cost of investment divided by the current share price so,

Number of new shares= 850,000/67= 12686.57

The earnings per share after the stock offer will be:-

EPS₁=  94,89,15/(12686.57+35000)= $19.9

The current P/E ratio is:

P/E₀ =67/21.43 = 3.15

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

P₁=3.15*19.9=62.685

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

BVPS₀=TE₀/Shares₀=32,00,000/35000=$91.42

BVPS₁=TE₁/Shares₁=32,00,000+850,000/(12686.57+35000)=$84.93

so the current and the new market to book ratio is:

Market to book ratio₀ = 67/91.42 = 0.7329

Market to book ratio₁= 62.685/84.93 =0.7380

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

NPV= -850000+ [62.685*(12686.57+35000)-67*35000]=$-205,767

Accounting dilution takes place here because the market to book ratio is less than one.

Market value dilution has occured since the firm is investing in negative NPV project