Question

Consider two​ firms, Firm X and Firm​ Y, that have identical assets that generate identical cash flows. Firm Y is an a minus equity ​firm, with 1 million shares outstanding that trade for a price of​ $24 per share. Firm X has 2 million shares outstanding and​ $12 million in debt at an interest rate of​ 5%.

According to MM Proposition I, the stock price for Firm X is closest to ________.

Answer 1

$26.52.

Step-by-step explanation:

We use the MM Proposition I formula as follows:

VL = VU + (Tc * D) ....................................................... (1)

Where;

VL = Value of a levered firm, i.e. X = ?

VU = Value of an unlevered firm, i.e. Y = $24

Tc = Tax rate = 21%

D = value of debt = $12

Note: The US 2020 corporate tax rate is used as the tax rate since no tax rate is given in the question.

Substituting the values into equation (1), we have:

VL = $24 + (21% * $12) = $24 + $2.52 = $26.52.

Therefore, According to MM Proposition I, the stock price for Firm X is closest to $26.52.