In: Finance
Suppose Sigma Industries and Pi Technology have identical assets that generate identical cash flows. Sigma Industries is an all-equity firm, with 9 million shares outstanding that trade for a price of $18.00 per share. Pi Technology has 24 million shares outstanding, as well as debt of $48.60 million. a. According to MM Proposition I, what is the stock price for Pi Technology? b. Suppose Pi Technology stock currently trades for $12.68 per share. What arbitrage opportunity is available? What assumptions are necessary to exploit this opportunity?
Qa:
According to the MM proposition I ; total value of a company should be same irrespective of capital structure if both the company generates identical cashflows and have identical assets.
Value of Sigma industries= no of shares*share price= 9*18=162 million $
Value of Pi Technology=162 million (identical firm with identical cashflows)
Value of Pi technology=162 =value of equity+value of debt
162= 24*share price +48.6
share price of Pi Technology= 4.725 $
Qb:
Since estimated share price is lower than current trading price of 12.68$ per share; we can go short for this stock of Pi technology in an anticipation of the share price moving towards its estimated fare value; And by this getting an arbitrage profit
Qc:
The assumptions needed are