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 155,000 shares of stock outstanding and $2.3 million in debt outstanding. The interest rate on the debt is 6 percent and there are no taxes.
a. Use M&M 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 round your answers to the nearest whole dollar amount, e.g., 32.)

Answer 1

Answer:

a. Price per share: $46

b. The value of the firm under the two proposed plans is the same at $9,430,000.

Explanation:

a.

Under the M&M Proposition I, the value of Unleveraged firm is equal to the value of Leveraged firm.

Denote x is the price per share, we have:

205,000 * x = 155,000 * x + 2,300,000 <=> 50,000 * x = 2,300,000 <=> x = $46

Thus, price per share is $46.

b.

As stated in part (a), value of unleveraged firm ( Plan I) and leveraged firm (Plan II) is the same because the value of the firm is dependent on its abilities to generating net cash flow in the future rather than its capital structure.

The value of the firm for both plan is calculated as:

205,00 x 46 = $9,430,000 or 155,000 x 46 + 2,300,000 = $9,430,000.