Question

Levered, Inc., and Unlevered, Inc., are identical in every way except their capital structures. Each company expects to earn $29.6 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 $97 million and costs 8 percent per year. Levered has 2.9 million shares outstanding that sell for $111 per share. Unlevered has no debt and 5.1 million shares outstanding, currently worth $86 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.)

Answer 1

Value of unlevered firm = no. of shares*price per share = 5.1 million shares*$86 = $438,600,000

As per Modigliani- Miller proposition I value of levered firm (in the absence of tax) = value of an identical unlevered firm

Thus value (or market value) of levered firm = $438,600,000

No. of shares outstanding of levered firm = 2.9 million

Thus market value of equity of levered firm = 2.9 million shares*$111 = $321,900,000

Now, value of firm = market value of debt+market value of equity

So, value = $9,700,000 + $321,900,000

= $331,600,000

Value of equity of unlevered firm = $438,600,000

market value of equity of levered firm = $321,900,000