Question

Kyle 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 755,000 shares of stock outstanding. Under Plan II, there would be 505,000 shares of stock outstanding and $8.75 million in debt outstanding. The interest rate on the debt is 7 percent, and there are no taxes.

Use M&M Proposition I to find the price per share of equity. (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

Share price            $

What is the value of the firm under Plan I? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Round your answer to the nearest whole number, e.g., 32.)

Value of the firm            $   

What is the value of the firm under Plan II? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Round your answer to the nearest whole number, e.g., 32.)

Value of the firm

Answer 1

Kyle Corporation
Use M&M Proposition I to find the price per share of equity.
We can find the per share price by figuring out the price per share paid using the $8.75 million in debt.
There were initially 755,000 shares with the all equity plan, but there are only 505,000 shares with the
levered plan, so they bought back 250,000 shares.
Price per share = amount of debt issued/(Old # of shares – New # of shares)=8.75mil/(755,000-505,000)=$35
What is the value of the firm under Plan I?
VU=35*755,000=26.425 million
What is the value of the firm under plan II?
VL = VU + (TR)(D)= 26.425 million