Company A and Company B are similar companies operating in thesame industry. Initially, both Company A and
Question:
Company A and Company B are similar companies operating in thesame industry.
Initially, both Company A and Company B have an enterprise valueof $400 million ? that is to say, the value of the operatingbusiness is $400 million. Note that the enterprise value is thesame as the market value of equity (Share price x number of sharesoutstanding = $400 million) for Company A and different from marketvalue of equity for Company B.
Company A has no net debt and Company B has $200 million in netdebt. (Note that Company B could have $100 million in cash and $300million in debt or simply no cash and $200 million in debt. It?sthe net debt that matters in this analysis.)
Industry conditions change and the value of all businesses inthis industry sector doubles overnight. That means the enterprisevalue (the value of the operating business) for both companiesdoubles.
What is the return earned by equity investors in Company A?Company B?