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 $ 30

Number of shares 30,000

Total assets $ 8,600,000

Total liabilities $ 4,400,000

Net income $ 780,000

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 ROE on the investment would have to be________ percent (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) if we wanted the price after the offering to be $30 per share (assume the PE ratio remains constant), and the NPV of the investment would be $________ (Leave no cells blank - be certain to enter "0" wherever required. Do not round intermediate calculations.). Accounting dilution does occur in this case. Market value dilution does not occur in this case.

Answer 1

a)	As per given problem, Current Stock Price is $30
	and we wanted price after offering new investment
	is also $30. In ddition to this investment has the same
	PE Ratio as the firm.
	So, EPS of the Investment will also be same as the firm.
	EPS of Investment
	= EPS of Firm
	= Current Net Income / Current Number of Shares
	= $780000 / 30000
	= $26
	New Shares issued for Investment
	= New Investment / Current Stock Price
	= $750000 / $30
	= 25000 Shares
	New Net Income
	= EPS of Investment * New Shares Issued
	= $26 * 25000 Shares
	= $650000
	ROE on Investment
	= New Net Income / Investment
	= $650000 / $750000
	= 0.8667
	i.e. 86.67%
b)	NPV
	= -Initial Investment + New Market Value of the Company - Current Market Value of the Company
	= -Initial Investment + (New Market Price * Total New Shares) - (Current Market Price*Current Shares)
	= -$750000 + ($30*(30000+25000)) - ($30*30000)
	= -$750000 + ($30*55000) - $900000
	= -$750000 + $1650000 - $900000
	= 0
c)	Current Book Value Per Share
	= Equity / Current No of Shares
	= (Total Assets - Total Liabilities) / Current No of Shares
	= ($8600000 - $4400000) / 30000
	= $4200000 / 30000
	= $140
	New Book Value of Shares
	= (Current Equity + Investments) / (Current No of Shares + New Issued)
	= (Total Assets-Total Liabilities+ Investments) / (Current No of Shares + New Issued)
	= ($8600000-$4400000+$750000) / (30000+25000)
	= $4950000 / 55000
	= $90
	Account dilution does occur as book value per share decreases from $140 to $90.
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