Question

In: Finance

Suppose Sigma Industries and Pi Technology have identical assets that generate identical cash flows. Sigma Industries...

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?

Solutions

Expert Solution

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

  • There is no tax benefit in the system
  • Companys capital structure doesnt affect firm value (MM 1 proposition exist)
  • Markets are perfectly efficient and complete

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