Question

Franklin Corporation 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 155,000 shares of stock outstanding. Under Plan II, there would be 105,000 shares of stock outstanding and $1.33 million in debt outstanding. The interest rate on the debt is 6 percent and there are no taxes.

Required:
a. Use MM Proposition I to find the price per share.
b. What is the value of the firm under each of the two proposed plans?

Answer 1

Answer and Explanation:

The computation is shown below:

a. The price per share under MM proposition is

= Debt ÷ Difference in Number of shares

= $1,330,000 ÷ (155,000 - 105,000)

= $26.60

b. The value of the firm under each plans is

For All equity plan

= Share price × Number of shares

= $26.6 × 155,000 shares

= $4,123,000

For Levered plan

= All equity plan value + Debt × Tax rate

= $4,123,000 + $1,330,000 × 0%

= $4,123,000