1. The DRK Corporation recently developed a dividend reinvestment plan (DRIP). The plan allows investors to reinvest cash dividends automatically in DRK in exchange for new shares of stock. Over time, investors in DRK will be able to build their holdings by reinvesting dividends to purchase additional shares of the company. Over 1,000 companies offer dividend reinvestment plans. Most companies with DRIPs charge no brokerage or service fees. In fact, the shares of DRK will be purchased at a 10 percent discount from the market price. A consultant for DRK estimates that about 75 percent of DRK's shareholders will take part in this plan. This is somewhat higher than the average. Evaluate DRK's dividend reinvestment plan. Will it increase shareholder wealth? Discuss the advantages and disadvantages involved here.

2. STEPHENSON REAL ESTATE RECAPITALIZATION

Robert Stephenson founded Stephenson Real Estate Company years ago and is its current CEO. The company purchases real estate, including land and buildings, and rents the property to tenants. The company has shown a profit every year for the past 18 years, and the shareholders are satisfied with the company's management. Prior to founding Stephenson Real Estate, Robert was the founder and CEO of a failed alpaca farming operation. The resulting bankruptcy made him extremely averse to debt financing. As a result, the company is entirely equity financed, with 9 million shares of common stock outstanding. The stock currently trades at $42.50 per share. Stephenson is evaluating a plan to purchase a huge tract of land in the southeastern United States for $50 million. The land will subsequently be leased to tenant farmers. This purchase is expected to increase Stephenson's annual pretax earnings by $12 million in perpetuity. Kim Weyand, the company's new CFO, has been put in charge of the project. Kim has determined that the company's current cost of capital is 12.5 percent. She feels that the company would be more valuable if it included debt in its capital structure, so she is evaluating whether the company should issue debt to entirely finance the project. Based on some conversations with investment banks, she thinks that the company can issue bonds at par value with an 8 percent coupon rate. From her analysis, she also believes that a capital structure in the range of 70 percent equity/30 percent debt would be optimal. If the company goes beyond 30 percent debt, its bonds would carry a lower rating and a much higher coupon because the possibility of financial distress and the associated costs would rise sharply. Stephenson has a 40 percent corporate tax rate (state and federal).

a. If Stephenson wishes to maximize its total market value, would you recommend that it issue debt or equity to finance the land purchase? Explain.

b. Construct Stephenson's market value balance sheet before it announces the purchase.

c. Suppose Stephenson decides to issue equity to finance the purchase.

i. What is the net present value of the project?

ii. Construct Stephenson's market value balance sheet after it announces that the firm will finance the purchase using equity. What would be the new price per share of the firm's stock? How many shares will Stephenson need to issue to finance the purchase?

iii. Construct Stephenson's market value balance sheet after the equity issue but before the purchase has been made. How many shares of common stock does Stephenson have outstanding? What is the price per share of the firm's stock? d. Construct Stephenson's market value balance sheet after the purchase has been made.

d. Suppose Stephenson decides to issue debt to finance the purchase.

i. What will the market value of the Stephenson Company be if the purchase is financed with debt?

ii. Construct Stephenson's market value balance sheet after both the debt issue and the land purchase. What is the price per share of the firm's stock?

e. Which method of financing maximizes the per-share stock price of Stephenson's equity?

3. COST OF CAPITAL FOR HUBBARD COMPUTER, INC.

Hubbard Computer, Inc. (HCI) has recently hired you in its relatively new treasury management department. HCI was founded eight years ago by Bob Hubbard and currently operates 74 stores in the Southeast. HCI is privately owned by Bob and his family, and had sales of $97 million last year. HCI primarily sells to in-store customers who come to the store and talk with a sales representative. The sales representative assists the customer in determining the type of computer and peripherals that are necessary for the individual customer's computing needs. After the order is taken, the customer pays for the order immediately, and the computer is made to fill the order. Delivery of the computer averages 15 days, and it is guaranteed in 30 days.

QUESTIONS

HCI's growth to date has been financed by its profits. When the company had sufficient capital, it would open a new store. Other than scouting locations, relatively little formal analysis has been used in its capital budgeting process. Bob has just read about capital budgeting techniques and has come to you for help. For starters, the company has never attempted to determine its cost of capital, and Bob would like you to perform the analysis. Since the company is privately owned, it is difficult to determine the cost of equity for the company. Bob wants you to use the pure play approach to estimating the cost of capital for HCI, and he has chosen Dell as a representative company. The following steps will allow you to calculate this estimate.

a. Most publicly traded corporations are required to submit quarterly (10Q) and annual reports (10K) to the SEC detailing the financial operations of the company over the past quarter or year, respectively. These corporate filings are available on the SEC website at www.sec.gov. Go to the SEC website and search for SEC filings made by Dell. Find the most recent 10Q or 10K and download the form. Look on the balance sheet to find the book value of debt and the book value of equity. If you look further down the report, you should find a section titled "Long-term Debt and Interest Rate Risk Management" that will provide a breakdown of Dell's long-term debt.

b. To estimate the cost of equity for Dell, go to finance.yahoo.com and enter the ticker symbol DELL. Follow the various links to answer the following questions: What is the most recent stock price listed for Dell? What is the market value of equity, or market capitalization? How many shares of stock does Dell have outstanding? What is the most recent annual dividend? Can you use the dividend discount model in this case? What is the beta for Dell? Now go back to finance.yahoo.com and find the "Bonds" link. What is the yield on 3-month Treasury bills? Using the historical market risk premium, what is the cost of equity for Dell using the CAPM?

c. You now need to calculate the cost of debt for Dell. Go to www.nasdbondinfo.com, enter Dell as the company and find the yield to maturity for each of Dell's bonds. What is the weighted aver-age cost of debt for Dell using the book value weights and the market value weights? Does it make a difference in this case if you use book value weights or market value weights?

d. You now have all the necessary information to calculate the weighted average cost of capital for Dell. Calculate the weighted average cost of cap-ital for Dell using book value weights and market value weights. Assume Dell has a 35 percent marginal tax rate. Which cost of capital number is more relevant?

e. You used Dell as a pure play company to estimate the cost of capital for HCI. Are there any potential problems with this approach in this situation?

4. What was the largest IPO? Go to www.hoovers.com and find out. In what country was the company located? What was the largest IPO in the United States?