The Metallica Heavy Metal Mining (MHMM) Corporation wants to diversify its opera

Question

The Metallica Heavy Metal Mining (MHMM) Corporation wants to diversify its operations. Some recent financial information for the company is shown here: MHMM is considering an investment that has the same PE ratio as the firm. The cost of the investment is $640.000. 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 (Round your answer to 2 decimal places (e.g., 32.16).) if we wanted the price after the offering to be $50 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 occur in this case. Market value dilution occur in this case.

Explanation / Answer

The current ROE of the company is:

Here TE0 = $510000
ROE0 = NI0/TE0 = $600,000/$5,100,000 = .1176 or 11.76%
The new net income will be the ROE times the new total equity, or:
NI1 = (ROE0)(TE1) = .1176($5,100,000 + 640,000) = $675,024
The company’s current earnings per share are:
EPS0 = NI0/Shares outstanding0 = $600,000/30,000 shares = $20.00
The number of shares the company will offer is the cost of the investment divided by the current
share price, so:
Number of new shares = $640,000/$50 = 12,800
The earnings per share after the stock offer will be:
EPS1 =$675,024/$42,800 shares = $15.77

The current P/E ratio is:
(P/E)0 = $50/$20 = 2.5

Assuming the P/E remains constant, the new stock price will be:
P1 = 2.5($15.77) = $39.425
The current book value per share and the new book value per share are:
BVPS0 = TE0/shares0 = $5,100,000/30,000 shares = $170 per share
BVPS1 = TE1/shares1 = ($5,100,000 + 640,000)/42,800 shares = $134.11 per share
So the current and new market-to-book ratios are:
Market-to-book0 = $50/$170 = 0.294
Market-to-book1 = $39.425/$134.11 = 0.294
The NPV of the project is the new market value of the firm minus the current market value of the
firm, or:
NPV = –$640000 + [$39.425(42800) – $50(30000)] = –$452610
Accounting dilution takes place here because the market-to-book ratio is less than one. Market value
dilution has occurred since the firm is investing in a negative NPV project.

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