Question

Kyle Corporation is comparing two different capital structures, an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, Kyle would have 400,000 shares of stock outstanding. Under Plan II, there would be 260,000 shares of stock outstanding and $6,020,000 in debt outstanding. The interest rate on the debt is 10 percent, and there are no taxes.
1. Use M&M Proposition I to find the price per share of equity.
2. What is the value of the firm under Plan I?
3. What is the value of the firm under Plan II?

Answer 1

Answer:

1. $43.00 per share

2. $17,200,000 (Under equity plan)

3. $17,200,000 (Under levered plan)

Explanation:

1. With the use of  M&M Proposition the computation of the price per share of equity is shown below:-

Price per share of equity = Debt outstanding ÷ (Shares of stock outstanding of Plan I - Shares of stock outstanding of Plan II)

= $6,020,000 ÷ (400,000 - 260,000)

= $6,020,000 ÷ 140,000

= $43.00 per share

2. The computation of value of the firm under Plan I is given below:-

Under all equity plan

Value of the firm under Plan I = Price per share of equity × Shares of stock outstanding of Plan I

= $43.00 × 400,000

= $17,200,000

3. The computation of value of the firm under Plan II is given below:-

Value of the firm under Plan II = Price per share of equity × Shares of stock outstanding of Plan II + Debt outstanding

Under levered plan

= $43.00 × 260,000 + $6,020,000

= $11,180,000 + $6,020,000

= $17,200,000