Sanborn Corp. is comparing two different capital structures. Plan I would result

Question

Sanborn Corp. is comparing two different capital structures. Plan I would result in 9,000 shares of stock and $80,000 in debt. Plan II would result in 7,500 shares of stock and $120,000 in debt. The interest rate on the debt is 8 percent. Assume that EBIT will be $50,000. An all-equity plan would result in 12,000 shares of stock outstanding. Ignore taxes. What is the price per share of equity under Plan I? Plan II? (Do not round intermediate calculations and round your final answers to 2 decimal places (e.g., 32.16).)

Explanation / Answer

Let share price be $x. Therefore,

Value of the firm in Plan I = 9,000 * x + 80,000

Value of the firm in Plan II = 7,500 * x + 120,000

Value of the firm is the same in both cases. Therefore,

9,000 * x + 80,000 = 7,500 * x + 120,000

=> 1,500 * x = 40,000

=> x = 26.67

Therefore, the share price is $26.67.

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