Question

Gael 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 185,000 shares of stock outstanding. Under Plan II, there would be 135,000 shares of stock outstanding and $2.29 million in debt outstanding. The interest rate on the debt is 5 percent and there are no taxes. 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.) 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

The value of firm under both plan is $8,473,000

Step-by-step explanation:

All equity plan share Outstanding = $185,000

Plan II Number. of shares outstanding = $135,000

Debt = $2,290,000

Price per share = Amount of debt issued/(No of shares in all Equity-no of shares in debt plan)

Price per share = $2,290,000/($185,000 - $135,000)

Price per share = $2,290,000 / $50,000

Price per share =$45.8

Value of firm under Equity plan = Number of shares * Price per share

Value of firm under Equity plan = 185000 shares * $45.8

Value of firm under Equity plan = $8,473,000

Levered plan = (Number of shares*Price per share) + Debt

Levered plan = (135,000 * $45.8) + $2,290,000

Levered plan = $6,183,000 + $2,290,000

Levered plan = $8,473,000

Hence, the value of firm under both plan is $8,473,000