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	$	40
Number of shares		30,000
Total assets	$	8,000,000
Total liabilities	$	3,500,000
Net income	$	360,000

   
The company 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. (Do not round intermediate calculations.)

The ROE on the investment would have to be  percent (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 $40 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.). Accounting dilution   (Click to select)   does not   does  occur in this case. Market value dilution   (Click to select)   does   does not  occur in this case.

Answer 1

ROE (Current)	Net income/Equity
ROE (Current)	360000/(8000000-3500000)
ROE (Current)	360000/4500000
ROE (Current)	8.00%
The new net income after project
New net income	ROE*Equity
New net income	8%*(4500000+750000)
New net income	420000
Earnings per share (Current)	Net income/No of shares outstanding
Earnings per share (Current)	360000/30000
Earnings per share (Current)	$12.00
No of new shares to be issued	750000/40
No of new shares to be issued	18750
Earnings per share after stock offer	420000/(30000+18750)
Earnings per share after stock offer	$8.62
PE ratio (Current)	Market price/Earnings per share
PE ratio (Current)	40/12
PE ratio (Current)	3.333
Calculation of new EPS using PE ratio
Earnings per share	Market price/PE ratio
Earnings per share	40/3.333
Earnings per share	$12.00
Therefore additional net income from investment
Net income	12*18750
Net income	$225,000
New ROE	225000/7500000
New ROE	30.00%
Net present value is calculated as cost of project plus new market value of firm less current market value
Net present value	-750,000+((40*48750)-(40*30000))
Net present value	-750000+(1950000-1200000)
Net present value	0
BVPS (Current)	Value of equity/No of shares outstanding
BVPS (Current)	4500000/30000
BVPS (Current)	$150	per share
New BVPS	Value of equity/No of shares outstanding
New BVPS	(4500000+750000)/(18750+30000)
New BVPS	5250000/48750
New BVPS	$107.69	per share
Thus, there is accounting dilution as book value per share drops from 150 to 107.69
However there is no market dilution as firm is investing in project with zero NPV
The ROE on the investment would be 30.00%
If we wanted the price after offering to be $50 per share and the NPV of the investment would be $0
Accounting dilution does occur in this case. Market value dilution does not occur in this case