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 $ 90 Number of shares 25,000 Total assets $ 7,700,000 Total liabilities $ 3,700,000 Net income $ 640,000 MHMM is considering an investment that has the same PE ratio as the firm. The cost of the investment is $700,000, 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.)

Answer 1

Current ROE = Net Income / Equity = $640000 / 4000000 = 16%

1. Current Book Value per share = (Asset - Liabilities) / Shares O/s = (7700000 - 3700000) / 25000 = $160

New Shares Issued = Amount Needed / Market Price = $700000 / 90 = 7778 Shares

New Book Value per Share = (4000000 + 700000) / 32778 = $143.39 per Share

2. Current EPS = Net Income / Shares O/s = $640000 / 25000 = $25.60 per Share

Net Income after Issue = 4700000 * 16% = $752000

New EPS = Net Income / 32778 = $22.94

3. Current Market to Book Ratio = Market Price / Book Value = $90 / 160 = 0.5625

Price after issue = Current PE Ratio * New EPS = (90 / 25.60) * 22.94 = $80.65

New Market to Book ratio = $80.65 / 143.39 = 0.5624

4. NPV = Cost of Investment - (New Market Value - Old Market Value)

-700000 + {80.65 * 32778 - 90 * 25000) = -$306454