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12 November, 08:28

Kyle Corporation is comparing two different capital structures, an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, Kyle would have 400,000 shares of stock outstanding. Under Plan II, there would be 260,000 shares of stock outstanding and $6,020,000 in debt outstanding. The interest rate on the debt is 10 percent, and there are no taxes.

1. Use M&M Proposition I to find the price per share of equity.

2. What is the value of the firm under Plan I?

3. What is the value of the firm under Plan II?

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Answers (1)
  1. 12 November, 10:30
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    1. $43.00 per share

    2. $17,200,000 (Under equity plan)

    3. $17,200,000 (Under levered plan)

    Explanation:

    1. With the use of M&M Proposition the computation of the price per share of equity is shown below:-

    Price per share of equity = Debt outstanding : (Shares of stock outstanding of Plan I - Shares of stock outstanding of Plan II)

    = $6,020,000 : (400,000 - 260,000)

    = $6,020,000 : 140,000

    = $43.00 per share

    2. The computation of value of the firm under Plan I is given below:-

    Under all equity plan

    Value of the firm under Plan I = Price per share of equity * Shares of stock outstanding of Plan I

    = $43.00 * 400,000

    = $17,200,000

    3. The computation of value of the firm under Plan II is given below:-

    Value of the firm under Plan II = Price per share of equity * Shares of stock outstanding of Plan II + Debt outstanding

    Under levered plan

    = $43.00 * 260,000 + $6,020,000

    = $11,180,000 + $6,020,000

    = $17,200,000
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