The Cramden Bus Company Is Currently All Equity Financed,but It

question 48

Multiple Choice

The Cramden Bus Company is currently all equity financed,but it is considering a leveraged capital structure,the details of which are presented in the table under the column labeled 'Proposed'.
Assume that the company generates perpetual annual EBIT.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 annual coupons (and yield) of 4%.
If Cramden recapitalizes,it will use the borrowed funds to repurchase (and cancel) shares.Determine both the value of the company and the value of the company's equity if it recapitalizes.

• A) Company value: $2,875,000; Equity value: $2,185,000
• B) Company value: $2,875,000; Equity value: $2,875,000
• C) Company value: $2,185,000; Equity value: $2,185,000
• D) Company value: $2,300,000; Equity value: $1,610,000
• E) Company value: $2,300,000; Equity value: $2,990,000

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Definitions:

Prospectus

A document required that describes the current status of a business and its future prospects.

Over-subscription

A situation where the demand for a company's new share offering exceeds the available supply.

AASB 101

Denotes the Australian Accounting Standards Board Standard 101, prescribing the basis for presentation of general purpose financial statements to ensure comparability both with the entity's financial statements of previous periods and with the financial statements of other entities.

Equity

Equity represents the value that would be returned to a company's shareholders if all of the assets were liquidated and all of the company's debts were paid off.