Pendergast Inc is a Major Real Estate Firm

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Pendergast, Inc. is a major real estate firm founded over 20 years ago and has been profitable for the past 18 years. The CEO of the firm had a prior business venture where the firm went bankrupt. For this reason, the CEO of Pendergast is very hesitant to take on debt, in fact, Pendergast, Inc. is currently 100% equity. Pendergast’s CEO is very conservative and has gone through the “great recession” which started in the real estate industry. He knows the consequences of changes in the economy. Another factor the CEO is considering is the company image in the marketplace. His Board of Directors has discussed the need to keep investor and “market” confidence in the firm and its share price high.

There is a new opportunity to purchase a large tract of land for $95mm, and the land will be leased out to farmers, resulting in annual revenues of $18.75mm in perpetuity (“forever”). Pendergast has the choice of selling more stock to finance the purchase or use debt, maybe do a mix of the two types of funding. The CFO is urging for debt because it should lower their cost of capital. The CFO has been talking with the investment bankers and believes that the firm could issue bonds at par paying an annual coupon of 6%. The firm currently has 9 million shares outstanding and the stock sells for $37.80 per share.

Complicating the issue is the uncertainty in the economy. The annual revenues are based on an average economy, and they would be the same in a strong economy. However, if there is a recession, it will be much harder to lease out all the land. The greater the depth of the recession, the harder it will be to lease the land. Don’t forget that Pendergast has revenues from its existing operations to consider as well. Another consideration is if the firm takes on too much debt, its credit ratings may drop, leading to higher financing costs.

For this discussion, 1) what are the factors that should be considered for this firm as they consider ways to finance the $95mm land purchase? There are always pros and cons to everything, and capital structure decisions are crucial to a firm’s success. Don’t forget about “signaling” in the marketplace, that too is a factor to add to this discussion. The discussion does not require a full mathematical solution, but there are certain key numbers that should be considered to help support your argument.

2) What recommendations would you make to the firm on their financing for the project?

Other info that may help if you want to do more analysis: Current cost of debt = 10.2%, tax rate = 40%

Pendergast Inc is a Major Real Estate Firm

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