Answer:
Consider the following calculation
Explanation:
For unlevered firm
Total Number of equity = 200,000
For levered firm
Total number of equity = 150,000
Value of debt = $2,150,000
Under M&M Proposition I, that is there is no rule of tax in economy. So there is not benefit of tax shield on the debt securities. So debt will be same as equity. Only deference between debt and equity M&M Proposition I is the debt has obligation to pay 5% interest per annum.
By using M&M Proposition I, price of equity is calculated below:
Price of equity = $2,150,000 / (200,000 – 150,000)
= $43.00
Hence, by using M&M Proposition I, price of equity is $43.40.
Value of firm under Unlevered firm = $43.00 × 200,000
= $8,600,000
Hence, value of unlevered firm is $8,600,000.
Value of levered firm = ($43 × 150,000) + $2,150,000
= $6,450,000 + $2,150,000
= $8,600,000
Hence, value of levered firm is $8,600,000
