Question

Consider two firms, Firm A and Firm B that have identical assets that generate identical cash flows. Firm A has $10 million in debt and has 3 million shares outstanding. Firm A’s stock is traded at $10 per share. Firm B is all-equity firm with 5 million shares outstanding. Under the M&M world with perfect capital markets, what would be the stock price for Firm B?

Answer 1

$6 is the stock price of Firm B.

Step-by-step explanation:

In a perfect competition under MM approach the value of an unlevered firm and value of a levered firm are same so,

Value of firm A= Value of firm B

Number of equity shares* Price of equity shares of firm A = Number of equity shares* Price of equity shares of firm B

10*3= 5*price of shares of firm B

So, Price of shares of firm B= (30/5)= 6