Rise Against Corporation is comparing t different capital structures, an all-equ

Question

Rise Against Corporation is comparing t different capital structures, an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, the company would have 175.000 shares of stock outstanding. Under Plan Il, there would be 125,000 shares of stock outstanding and $2.23 million in debt outstanding. The interest rate on the debt is 8 percent and there are no taxes. Use M&M; Proposition Ito find the price per share. (Round your answer to 2 decimal places. (e.g., 32.16)) What is the value of the firm under each of the two proposed plans? (Do not round intermediate calculations and round your final answers to the nearest whole dollar amount. (e.g., 32)) All equity plan Levered plan

Explanation / Answer

Answer:

The M&M theory proposition I states that value of a firm is independent of percentage of debt or equity in its capital structure. It means- Value of a levered firm = Value of an unlevered firm

1) Let the share price be 'X'

Then as per the equation:

Value under plan I = Value under plan II

=> 175,000*X = 125,000*X + $2,230,000

=> 50,000X = $2,230,000

=> X = $2,230,000/50,000 = $44.6 (Ans)

2. Value of the firm under each plan=

All equity plan = 175,000 shares*$44.6 = $7,805,000

Levered Plan = 125,000*$44.6 + $2,230,000 = $7,805,000

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