Question

Foundation, Incorporated, 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 170,000 shares of stock outstanding. Under Plan II, there would be 120,000 shares of stock outstanding and $1.45 million in debt outstanding. The interest rate on the debt is 8 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

Using M&M Proposition I, the value of the firm remains the same at $102 million for both capital structures. The price per share under Plan I is $600, and under Plan II is $850. The difference in per-share price is due to the change in the number of shares and the deduction of debt interest in Plan II.

Step-by-step explanation:

Under Modigliani and Miller Proposition I (M&M I), the value of the firm is not affected by its capital structure in a world without taxes, bankruptcy costs, and asymmetric information. Therefore, the firm's total value should be equal with both Plan I and Plan II because it solely depends on the firm's earning power and business risk.

To find the price per share for both plans, we need to determine the value of the firm. Without the explicit profit or cash flow information, we cannot calculate it directly from the provided data. If we assume the total firm value to be $102 million as mentioned in the reference, then under Plan I the price per share would be $600 ($102 million / 170,000 shares), and under Plan II the price would be $850 ([$102 million - ($1.45 million × 8%)] / 120,000 shares)

The value of the firm under both Plan I and Plan II would be $102 million based on the information provided, considering the capital structure irrelevance under M&M I without taxes.