Question

Trapper 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 180,000 shares of stock outstanding. Under Plan II, there would be 130,000 shares of stock outstanding and $1.49 million in debt outstanding. The interest rate on the debt is 6 percent and there are no taxes.

  

a.  
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.)

b.   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 number, e.g., 32.)

Answer 1

Ans:- (a) In this part we need to find the price per share by M&M Proposition. For that first, we need to find the Value of Levered firm and Value of unlevered firm.

Let us assume Price the price share be x.

Now under Plan 1, the value of unlevered Firm will be given by (Number of outstanding shares * Price per share).

= 180000 * x

= 180000x.

Note: Unlevered firm is a firm that has no financial debt or leverage.

Now under Plan 2, the value of the levered firm will be given by ( Market Value of Equity + Market value of Debt)

= 130000x + 1490000.

Note:- Leveraged firm is a firm that has a high level of debt.

Now as per M&M( Modigliani-Miller) Proposition Value of Unlevered Firm will be equal to the Value of Levered firm.

Value of Unlevered Firm = Value of Levered Firm.

180000x = 130000x + 1490000

180000x - 130000x = 1490000.

50000x = 1490000

or x = 1490000 / 50000.

x = $29.8. is the price per share.

(b) Now the Under Plan 1 the value of Unlevered firm will be (180000 * 29.8)

= $53,64,000.

Under Plan 2, the value of Levered Firm will be (130000 * 29.8 + 1490000)

=$53,64,000.

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