Question

Problem 16-16 MM Proposition I

Levered, Inc., and Unlevered, Inc., are identical in every way except their capital structures. Each company expects to earn $12.5 million before interest per year in perpetuity, with each company distributing all its earnings as dividends. Levered’s perpetual debt has a market value of $73 million and costs 4 percent per year. Levered has 3.1 million shares outstanding that sell for $89 per share. Unlevered has no debt and 4.8 million shares outstanding, currently worth $72 per share. Neither firm pays taxes.

        

What is the value of each company's equity? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole number, e.g., 1,234,567.)

Correct answer for Unlevered is 345,600,000

Missing correct answered for Levered

Answer 1

Since unlevered is an all-equity from its value is equal to the market value of it's outstanding Shaxas. Cinlevexed bas 4.8 million shares of Common Stock Outstandiog worth $72 per Store Therefore, the value of conlevered Valuc of unie - 4,800,000 X72 = $345,600,000 Modigliani - Miller proposition. I States that, is the absence of taxes, the value of a levered firm equals the value of an otherwise identical anlevered firm. Since levered is identical to unlevered in every way except its Capital structure and neither firm pays tares, the value of the two firms should be equal. Therefore, the market value of Levered inc. should be $345, 600,000 also. Since Levered has 3.1 million shares outstanding worth $89 por share the market of levered's equite

Equity value of levered (EU) = 3100,000 $89=$275,900,000 The market value of Levered's debt is $ 73 million The value of a levered from equals the market Vallee of its debt plus the market value of equity. Therefore, the curreot market value of levered is Value of livered firm (VL) = DIEL = $ 73,000,000 +$275.900,000 - $348,900,000 The market value of levered's quity Deeds to be $ 345, 600,000 je. 3,300,000 lower than Lit's current market value of $348,900,ooo, for MM proposition I to hold good. Since levered's market value is more than Clolevered's market values levered is relatively overpriced and an investor I should sell shares of the firm's stock.