Question

Round Hammer 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 175,000 shares of stock outstanding. Under Plan II, 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.

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

A) total debt = $2,230,000 and it represents 175,000 - 125,000 = 50,000 outstanding shares

price per share = $2,230,000 / 50,000 = $44.60 per share

B) enterprise value = 175,000 x $44.60 = $7,805,000

According to M&M proposition I, the enterprise value is the same with or without any outstanding debt. So the company's value is the same for both alternatives.