Question

Byrd 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 205,000 shares of stock outstanding. Under Plan II, there would be 125,000 shares of stock outstanding and $1.73 million in debt outstanding. The interest rate on the debt is 8 percent and there are no taxes. a. Use MM 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 enter your answers in dollars, not millions of dollars, rounded to the nearest whole number, e.g., 1,234,567.)

Answer 1

Answer:

a) $21.63

b) $4,433,125

Explanation:

plan I, total stocks outstanding = 205,000

plan II, total stocks outstanding = 125,000, and $1,730,000 in debt ($1,730,000 x 8% = $138,400 in interests)

under MM proposition I, a firm's total value is equal whether it uses external financing (debt) or not:

205,000P₀ = 125,000P₀ + $1,730,000

205,000P₀ - 125,000P₀ = $1,730,000

80,000P₀ = $1,730,000

P₀ = $1,730,000 / 80,000 = $21.625 = $21.63

the firm's total value = $21.625 x 205,000 = $4,433,125