Question

XYZ, Inc. is an all-equity firm, with 1 million shares outstanding that trade for a price...

XYZ, Inc. is an all-equity firm, with 1 million shares outstanding that trade for a price of $19.95 per share.

OPQ, Inc. on the other hand, has 2 million shares outstanding, and $10 million in debt (par value) which currently trade at 110.

Assume that both firms have identical assets and identical cash flows.

According to the MM Proposition I without tax, what would be the stock price per share for firm OPQ?

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Answer #1

As per MM Proposition I without tax, Value of levered firm equals value of unlevered firm

XYZ Inc is an all-equity firm and hence an unlevered firm.

XYZ Value = Shares Outstanding * Trading price per share = 1,000,000*$19.95 = $19.95 Million

OPQ Inc. is an levered firm. The value of OPQ Inc. will equal value of XYZ Inc at $19.95 Million as per MM Proposition I without tax

Thus, (Value of Debt + value of Equity) of OPQ Inc = Value of XYZ Inc

Let the stock price of OPQ be X

($10 Million * 110/100)+(2,000,000*X) = $19.95 Million

= $11,000,000+(2,000,000*X) = $19,950,000

=(2,000,000*X) = $19,950,000-$11,000,000

=(2,000,000*X) = $8,950,000

=X = $8,950,000 / 2,000,000 = $4.475

The stock price per share for firm OPQ = $4.475

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