Lamont Corp. is debt-free and has a weighted average cost of capital of 12.7 percent. The current market value of the equity is $2.3 million and there are no taxes. According to M&M Proposition I, what will be the value of the company if it changes to a debt-equity ratio of .85?
A) $18,110,236
B) $1,955,000
C) $15,393,701
D) $2,705,882
E) $2,300,000

Question

Quizplus · Accepted Answer

According to Modigliani and Miller Proposition I (with no taxes), the total value of a leveraged firm is equal to the value of an unleveraged firm. This means that the capital structure changes (introduction of debt) do not affect the total value of the firm. Therefore, if Lamont Corp. is initially worth $2.3 million when it is debt-free, its value will remain $2.3 million regardless of the change in its debt-equity ratio.