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 180,000 shares of stock outstanding. Under Plan II, there would be 130,000 shares of stock outstanding and $2.27 million in debt outstanding. The interest rate on the debt is 8 percent and there are no taxes.
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Use M&M Proposition I to find the price per share. What is the value of the All-equity firm? What is the Levered plan firm value |
Plan I:
All-Equity Plan:
Number of shares = 180,000
Plan II:
Number of shares = 130,000
Value of debt = $2,270,000
Price per share = Value of debt under Plan II / (Number of
shares under Plan I - Number of shares under Plan II)
Price per share = $2,270,000 / (180,000 - 130,000)
Price per share = $2,270,000 / 50,000
Price per share = $45.40
Value of All-Equity Firm = Price per share * Number of
shares
Value of All-Equity Firm = $45.40 * 180,000
Value of All-Equity Firm = $8,172,000
Value of Levered Firm = Price per share * Number of shares +
Value of Debt
Value of Levered Firm = $45.40 * 130,000 + $2,270,000
Value of Levered Firm = $8,172,000
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