Assume you are in an M&M; world. ABC Corporation is unlevered and is valued at $

Question

Assume you are in an M&M; world. ABC Corporation is unlevered and is valued at $640,000. ABC is currently deciding whether including debt in their capital structure would increase live value. Under consideration is issuing $300,000 in new debt with an 8% interest rate. ABC would repurchase $300,000 of stock with the proceeds of the debt issue. 'there are currently 32,000 shares outstanding and their effective marginal tax bracket is zero. a) What will die firm value be after the changer? b) What will die share once be and how many shares will be outstanding after die change? Now assume you are in a Modigjiaru Miller world with corporate taxes added. XYZ Corp. is all equity financed with 5,000 shares outstanding world $7 each They tax planning on issuing $10,000 of n-w p-ipetual debt at die 8% market rate of interest. The effective tax rate is 25% c) What is the market value of the firm's outstanding equity after they make die debt for equity exchange?

Explanation / Answer

Modigliani - Miller ABC As per the theory of Modigliani and Miller - the value of levered and unlevered firm remains the same Cost of buying a levered firm is same as cost of buying an unlevered firm Old capital stucture New capital structure Current valuation of ABC $640,000 (Unlevered) Equity 640000 Total no. of share 32000 Less: - equity repurchased 300000 face value of share @20 each 340000 340000 Cost per share $20 No . Of shares Outstanding - post change   17000 Share price - 20 per share Debt @ 8 % $300,000 Total laibilites $640,000 Proposition - 1 without tax value of the firm = (E+D) (340000+300000) $640,000 Vu = VL ` Where Vu is the value of levered firm and VL is the value in unleverd firm XYZ Current capital stucture New capital structure Unlevered Equity - 5000 share @ 7 / share 35000 Debt @ 8% 10000 Equity share 35000 Value of firm 35000 Bought back from proceeds of Debt 10000 balance Equity 25000 25000 Proposition 1 - with Tax VL = Vu +(TAX rate * debt ) value of the firm = value of unlevered firm + ( tax rate * value of debt) 32000 +((1- 25%)*10000)) 32500

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.