Question

DAR Corporation is comparing two different capital structures, an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, the company would have 185,000 shares of stock outstanding. Under Plan II, there would be 135,000 shares of stock outstanding and $2.29 million in debt outstanding. The interest rate on the debt is 5 percent and there are no taxes.

Use M&M Proposition I to find the price per share. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Share price $ per share

What is the value of the firm under each of the two proposed plans? (Do not round intermediate calculations and round your answers to the nearest whole dollar amount, e.g., 32.)

All equity plan $

Levered plan $

Answer 1

In the absence of taxes, the value of any firm is independent of its capital structure and solely dependent on the firm's earnings power. Therefore, the value DAR Corporation under both plans would be equal to each other.

Let the share price be $ P

Firm Value Under Plan 1 = P x Number of Shares Outstanding = P x 185000

Firm Value Under Plan 2 = P x Number of Shares Outstanding + Debt = P x 135000 + 2290000

Therefore, P x 185000 = P x 135000 + 2290000

P = 2290000 / (185000 - 135000) = $ 45.8

Firm Value Under All Equity Plan = Firm Value Under Levered Plan = P x 185000 = 45.8 x 185000 = P x 135000 +2290000 = $ 8473000 or $ 8.473 million