The Mohawk & Hudson Railway (M&H)currently Has a Levered Capital

question 64

Multiple Choice

The Mohawk & Hudson Railway (M&H) currently has a levered capital structure,but it is considering a proposal to issue new equity (@$60/share) and use the proceeds to retire its debt.Selected financial information for M&H is provided in the table below.Assume that all cash flows occur at the end of the year and we are currently at the beginning of a year.Assume that taxes are zero.Assume that all of net income is paid out as a dividend.Assume that the debt is perpetual with an annual coupon rate of 4% (and yield of 4%) .Assume that individual investors can borrow and lend at the same interest rate (and with the same terms) as corporations.
Charlie Jones,an engineer for the railway,owns 100 shares of M&H.Charlie receives annual dividend income of $360 under the current capital structure.Charlie likes the lower risk and the return on investment that he could earn under the proposed all-equity capital structure,but Mohawk & Hudson has announced that it will not go forward with the change in capital structure.If Charlie sells 14.29 shares and lends the proceeds,then what are his annual investment cash flows?

• A) $260
• B) $294
• C) $308
• D) $343
• E) $360

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