M&M Proposition I (No Taxes)
You and your friend start competing businesses that operate in the software space: Erie Solutions and Cuyahoga Technologies. Both businesses are identical in every way except for their capital structures. You are more conservative with your finances so you decide to run Erie Solutions with no debt while your friend runs Cuyahoga Tech with some level of debt.
Erie Solutions has 100,000 shares and each share is worth $27.50. Cuyahoga Tech has $1,000,000 in debt. Both firms operate in a world with no taxes.
How much are the assets of Erie Solutions worth? (1 point)
How much are the assets of Cuyahoga Tech worth? (1 point)
What is Cuyahoga Tech’s value of equity? (1 point)
How much would it cost to buy 75% of the total equity of each company (in other words, how much would it cost to buy 75% of all shares outstanding for each company)? (1 point)
From an equity-investor perspective, which of the two firms is less risky as an investment opportunity? Please explain. (1 point)
M&M Proposition II (No Taxes)
Years later, Erie Solutions and Cuyahoga Tech have grown steadily but continue to be identical except for their capital structures. Neither firm pays taxes. Now both firms have EBIT of $1,000,000 in perpetuity. Erie Solutions continues to be unlevered and has equity worth $10,000,000 (the number of shares is unspecified). Cuyahoga Tech has equity worth $6,500,000 (number of shares unspecified) and has a cost of debt of 8.5%. (Note that this is a new set of facts. Do not use facts from Proposition I to solve this problem).
What is the Cost of Equity (or Return on Equity) for Erie Solutions? (1 point)
What is the Cost of Equity for Cuyahoga Tech? (1 point)
What is WACC for Erie Solutions? (1 point)
What is WACC for Cuyahoga Tech? (1 point)
Describe your observations from your WACC results for both companies. Should we expect to see these results? And if so, why? (1 point)
SPACs: SPACs come in different forms and shapes, but generally they sell their shares at $10 at IPO and will merge with a start-up within 24 months of going public. We will briefly cover SPACs when we’re back from Thanksgiving break, but in the meantime please watch this YouTube video in order to familiarize yourself with the concept:
https://www.youtube.com/watch?v=40IywkBBcQQ
Your task: Research an example of a SPAC that was successful in creating value for its shareholders (its stock price today is higher than at the time of the SPAC IPO, which is normally $10), and one that has not been successful at creating value for its shareholders.
For the SPAC that created value for its shareholders, please answer the following:
What is the name of the SPAC and the name of the new company after the merger took place? (1 pts)
If you had invested in the SPAC at IPO, what would be your return if you sold your position today (as of the day you’re doing this assignment)? Please show your calculations. (1 pts)
Researched reasons why the current stock price is higher than the SPAC stock price at IPO. Is it because of its business model, future prospects, high demand, etc? (1 pts)