In: Finance
Tom Scott is the
owner, president, and primary salesperson for Scott Manufacturing.
Because of this, the company's profits are driven by the amount of
work Tom does. If he works 40 hours each week, the company's EBIT
will be $570,000 per year; if he works a 50-hour week, the
company's EBIT will be $665,000 per year. The company is currently
worth $3.40 million. The company needs a cash infusion of $1.50
million, and it can issue equity or issue debt with an interest
rate of 10 percent. Assume there are no corporate taxes.
a. What are the cash flows to Tom under each
scenario? (Enter your answers in dollars, not millions of
dollars, e.g. 1,234,567. Do not round intermediate
calculations.)
Scenario-1
Debt issue:
Cash flows | |
40-hour week | $ |
50-hour week | $ |
Scenario-2
Equity issue:
Cash flows | |
40-hour week | $ |
50-hour week | $ |
b. Under which form of financing is Tom likely to
work harder?
Equity issue
Debt issue