Question

Round Hammer 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 175,000 shares of stock outstanding. Under Plan II, there would be 125,000 shares of stock outstanding and $2.23 million in debt outstanding. The interest rate on the debt is 8 percent and there are no taxes. a. 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.) b. 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.)

For a find the share price:

For B: All equity firm values:

And Levered plan firm value

Answer 1

Plan I:

Shares outstanding = 175,000

Plan II:

Shares outstanding = 125,000
Debt = $2,230,000

Answer a.

Price per share = Debt under Plan II / (Shares outstanding under Plan I - Shares outstanding under Plan II)
Price per share = $2,230,000 / (175,000 - 125,000)
Price per share = $2,230,000 / 50,000
Price per share = $44.60

Answer b.

Plan I:

Value of Firm = Price per share * Shares outstanding + Debt
Value of Firm = $44.60 * 175,000 + $0
Value of Firm = $7,805,000

Plan II:

Value of Firm = Price per share * Shares outstanding + Debt
Value of Firm = $44.60 * 125,000 + $2,230,000
Value of Firm = $7,805,000