1) Consider two firms, With and Without, that have identical assets that generate identical cash flows. Without is an all-equity firm, with 1 million shares outstanding that trade for a price of $24 per share. With has 2 million shares outstanding and $12 million dollars in debt at an interest rate of 5%. Assume that MM's perfect capital markets conditions are met and that you can borrow and lend at the same 5% rate as with. You have $5000 of your own money to invest and you plan on buying Without stock. Using homemade leverage, how much do you need to borrow in your margin account so that the payoff of your margined purchase of Without stock will be the same as a $5000 investment in With stock?
a) $10,000
b) $5000
c) $2,500
d) $0

2) Consider two firms, With and Without, that have identical assets that generate identical cash flows. Without is an all-equity firm, with 1 million shares outstanding that trade for a price of $24 per share. With has 2 million shares outstanding and $12 million dollars in debt at an interest rate of 5%. According to MM Proposition 1, the stock price for With is closest to:
a)$8.00
b)$24.00
c)$6.00
d)$12.00

Solution Preview

1) Consider two firms, With and Without, that have identical assets that generate identical cash flows. Without is an all-equity firm, with 1 million shares outstanding that trade for a price of $24 per share. With has 2 million shares outstanding and $12 million dollars in debt at an interest rate of 5%. Assume that MM's perfect capital markets conditions are met and that you can borrow and lend at the same 5% rate as with. You have $5000 of your own money to invest and you plan on buying Without stock. Using homemade leverage, how much do you need to borrow in your margin account so that the payoff of your margined purchase of Without stock will be the same as ...

Solution Summary

Two questions on capital structure using Miller and Modigliani have been answerd.

Consider a Modigliani-Miller world with no taxes. In this world, consider a firm which
is expected to generate constant cash flows in perpetuity. For this firm VU = VL = D+S
and ks = k0 + (D/S)(k0 - kd). Now, assume that suddenly, a corporate tax at a rate
T is imposed on the firm. Nothing else changes (i.e. the value of debt

Can you help me get started with this assignment?
Explain the Modiglianiand Miller models of capital structure both with and without corporate income taxes.
Specifically, explain the relationship between debt leverage and the value of the firm and between debt leverage and the cost of capital.

Can you help me get started with this assignment?
Explain the Modiglianiand Miller models of capital structure both with and without corporate income taxes. Specifically, explain the relationship between debt leverage and the value of the firm and between debt leverage and the cost of capital.

What are some of the differences between the theoretical M&M (Modigliani-Miller )propositions and the practical applications for managers? Where do managers say value is created?

Question 1:
Assume there are two companies operating in the same industry. The two companies are almost identical. The only difference is their capital structure. Company UU has only equity while company LL has 30% of debt and 70% of equity.
Further assume that both companies have the same expected net operating income of

Solve each question by analyzing the situation below.
A business with no debt financing has a firm value of $20 million. It has a corporate marginal tax rate of 34%. The firm's investors are estimated to have marginal tax rates of 31% on interest income and a weighted average of 28% on stock income. The business is plannin

Using the Modigliani/Miller propositions with taxes, calculate the change in the value of the firm and the change in the required return on equity if it borrows $2,000,000 and uses the funds to retire $2,000,000 of its equity. The cost of the debt will be 8% and the current required return on equity is 14%. Currently, the firm

Poulsbo Manufacturing, ZInc. is currently an all-equity firm that pays no taxes. The market value of the firm's equity is $4 million. The cost of this unlevered equity is 15 percent per annum. Poulsbo plans to issue $700,500 in debt and use the proceeds to repurchase stock. The cost of debt is 4 percent semi-annually.
A. Afte

Assume a world without taxes. Two firms, Mix Corp. and Dial Co. are identical in every way except for their capital structures. Mix, an all-equity firm, has 200000 shares of common stock outstanding; each share sells for $30. In addition to equity financing, Dial uses leverage; the market value of Dial's debt is $3,000,000, and

A firm finance completely with equity currently has a cost of capital equal to 15 percent. If Modiglianiand Miller's Proposition 1 holds and the firm is thinking about its capital structure to 50 percent debt and 50 percent equity, then what will be the cost of equity after the change if the cost of debt is 10 percent?