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 730,000 shares of stock outstanding. Under Plan II, there would be 480,000 shares of stock outstanding and $7.5 million in debt outstanding. The interest rate on the debt is 8 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.)

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.)

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.)

Answer 1

a). We can find the price per share by dividing the amount of debt used to repurchase shares by the number of shares repurchased. Doing so, we find the share price is:

Share price = $7,500,000 / (730,000 - 480,000) = $30 per share

b). The value of the company under the all-equity plan is:

V = $30 x 730,000 shares = $21,900,000

c). The value of the company under the levered plan is:

V = [$30 x 480,000 shares] + $7,500,000 debt  

= $14,400,000 + $7,500,000 = $21,900,000