James Corp is comparing two different capital structures: an all-equity plan (Pl

Question

James Corp is comparing two different capital structures: an all-equity plan (Plan1) and a levered plan (Plan II). Under Plan 1, the company would have 160,000 shares of stock outstanding. Under Plan II, there would be 80,000 shares of stock outstanding and $2.8 million in debt outstanding. The interest rate on the debt is 8 percent, and there are no taxes. Using M& M Proposition 1 to find the price per share of equity under each of the two proposed plans. What is the value of the firm?

Explanation / Answer

using Proposition I: Vu = V L value of the firm is as below. 160000 share x X = 80000 x X + $2800000 160000X - 80000 X = $2800000 80000X = 2800000 => X = 2800000 /80000 = $35 per share. Value of share = $35 per share. Value of the firm = 160000 x 35 = $5.6 million

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