Figure 111: Selected Information for Silicon Solutions Inc -According to Modigliani and Miller (M&M),in a World of Perfect

question 60

Essay

Figure 11.1: Selected information for Silicon Solutions Inc.
$\begin{array}{|l|l|l} \hline& \text { ALL EQUITY } & \text { EQUTTY AND DEBT } \\ \hline & & \\\hline \text { Number of shares } & 1,000,000 & 750,000 \\\hline \text { Price per share } & \$ 10 & \$ 10 \\\hline \text { Market value of shares } & \$ 10,000,000 & \$ 7,500,000 \\\hline \text { Market value of debt } & - & \$ 2,500,000 \\\hline & & \\\hline \text { Anticipated operating income } & \$ 1,000,000 & \$ 1,000,000 \\\hline \text { Interest } & - & \$ 150,000 \\\hline \text { Earnings (after interest) } & \$ 1,000,000 & \$ 850,000 \\\hline \text { Earnings per share } & \$ 1.00 & \$ 1.13 \\\hline \text { Return on shares } & & \\\text { Average cost of capital } & & \\\text { Return on debt } & & \\\hline\end{array}$
-According to Modigliani and Miller (M&M),in a world of perfect capital markets,what will be the expected equity return (or cost of equity)for a firm that has a cost of capital of 14 percent,a cost of debt of 8 percent,debt valued at $3.0 million,and equity valued at $4.0 million? What would happen to the cost of equity as the amount of debt increased? What would happen to the cost of debt if the amount of debt was increased?

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Definitions:

Total Cost Curve

A graphical representation that illustrates how the total cost of producing a good changes in relation to the quantity produced, considering both fixed and variable costs.

Diseconomies of Scale

Diseconomies of scale occur when a firm or business grows so large that the costs per unit increase, leading to inefficiency and higher production costs.

Total Revenue

The entire sum of funds a business gains from selling products or offering services over a specified timeframe.

Total Cost

The complete amount of money spent by a business to produce a specific quantity of goods or services, including both fixed and variable costs.