# Capital Structure Using Modigliani Miller Irrelevance Theorem PROBLEM 3.2. Consider a company which

Capital Structure Using Modigliani Miller Irrelevance Theorem PROBLEM 3.2. Consider a company which is due to generate a single cash-flow, equal either to SEK 2500 or to SEK 1500, in one year. The claims on the company&#39;s cash-flows consist of both debt and equity, and the company&#39;s shareholders have limited liability. The market value of the company is equal to SEK 1750, and the assumptions of Modigliani-Miller irrelevance theorem are satisfied. The risk-free rate of interest is equal to 2%. 3.2.1. Suppose that the company&#39;s debt consists of a single “bond.” This bond en- titles the investor(s) to a payment of SEK 1300 due in one year. Provide the current market value of the bond and the company&#39;s equity. 3.2.2. Suppose that the company&#39;s debt consists of a senior bond and a subordinate bond. The bonds entitle the investors to a payment of SEK 1300 and a payment of SEK 500, respectively; both payments are due in one year. Provide the current market value of each bond and the company&#39;s equity. Hint. In this Problem, we are given the market value of the company, Hence, to use the “replication” strategy to find the price of any given security, we must find a combination of an ideal security that includes both the firm&#39;s equity and the firm&#39;s debt, on one hand, and risk-free debt, on the other hand, whose value in each state is identical to that of the security to be priced. For example, using m and l to indicate the positions in the ideal security and risk-free debt, respectively, we can write the system determining the replicating portfolio for the firm&#39;s equity in 3.2.1 as: (2500 – 1300 = 2500 × m + 1.02 × l | 1500 – 1300 = 1500 × m + 1.02 × l