Kyle Corporation is comparing two different capital structures, an all-equity pl
ID: 1171291 • Letter: K
Question
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.
Use M&M Proposition I to find the price per share of equity.
What is the value of the firm under Plan I? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars (e.g., 1,234,567).)
What is the value of the firm under Plan II? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars (e.g., 1,234,567).)
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.
Explanation / Answer
Based on Miller and Modigliani proposition I, in case of no taxes, the capital structure does not influence the valuation of a firm.
Hence value of firm will remain same under both plans - Plan I and Plan II.
Value of Total Equity = Value per share * Number of shares outstanding
Question1
Value of firm, as mentioned earlier, is same under both plans. Let the share price be P.
This means, value of firm under plan 1 = 400,000 * P
Value of firm under Plan 2 = (260,000 * P) + $6,020,000
Now, equation both, we get
400,000 * P = 260,000 * P + 6020000
140,000 P = 6,020,000
P = $43
Question 2
Value of firm under Plan 1 = $43 * 400,000 = $17,200,000
Question 3
Value of firm under Plan21 = ($43 *260,000) + $6,020,000 = $17,200,000
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