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 320,000 shares of stock outstanding. Under Plan II, there would be 240,000 shares of stock outstanding and $2,272,000 in debt outstanding. The interest rate on the debt is 10 percent, and there are no taxes. a. Use M&M Proposition I to find the price per share of equity. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) b. What is the value of the firm under Plan I? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.) c. What is the value of the firm under Plan II? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

Answer 1

Plan II:

Number of shares = 320,000

Plan I:

Number of shares = 240,000
Value of debt = $2,272,000

Answer a.

Price per share = Value of debt under Plan II / (Number of shares Plan I - Number of shares under Plan II)
Price per share = $2,272,000 / (320,000 - 240,000)
Price per share = $2,272,000 / 80,000
Price per share = $28.40

Answer b.

Plan I:

Value of firm = Number of shares * Price per share + Value of debt
Value of firm = 320,000 * $28.40 + $0
Value of firm = $9,088,000

Answer c.

Plan II:

Value of firm = Number of shares * Price per share + Value of debt
Value of firm = 240,000 * $28.40 + $2,272,000
Value of firm = $9,088,000