Rolston Corporation is comparing two different capital structures, an all-equity

Question

Rolston Corporation is comparing two different capital structures, an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, Rolston would have 165,000 shares of stock outstanding. Under Plan II, there would be 115,000 shares of stock outstanding and $1.43 million in debt outstanding. The interest rate on the debt is 8 percent and there are no taxes. Use MM Proposition I to find the price per share. What is the value of the firm under each of the two proposed plans? Share price: All equity plan: Levered plan:

Explanation / Answer

Under MM proposition I without taxes, value of the firm is same irrespective of the capital structure

So Value of firm in Plan I = Value of firm in Plan II

Value of firm in Plan I = Value of firm in Plan II

165000 * P = 115000 * P + 1,430,000

50000 * P = 1430000

P = 1430000 / 50000 = 28.60

So value of the firm in plan I = 165000 * 28.60 = 4,719,000

value of the firm in plan II = 115000 * 28.60+ 1,430,000 = 4,719,000

Related Questions

Navigate

• Browse (All)
• Browse R
• Subjects

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