Question

Lydic Enterprises is considering a change from its current capital structure. The company currently has an all-equity capital structure and is considering a capital structure with 20 percent debt. There are currently 4,080 shares outstanding at a price per share of $50. EBIT is expected to remain constant at $34,853. The interest rate on new debt is 5 percent and there are no taxes. a. Rebecca owns $34,000 worth of stock in the company.

If the firm has a 100 percent payout, what is her cash flow? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Shareholder cash flow $ 5808.83

b. What would her cash flow be under the new capital structure assuming that she keeps all of her shares? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Shareholder cash flow $

c. Suppose the company does convert to the new capital structure. Show how Rebecca can maintain her current cash flow. (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

Number of shares stockholder should sell

Answer 1

a.
Share holder Cash flow i.e., dividend
= 34853 x 34000 / 204000
= 5808.8333333$
So Shareholder cash flow = $ 5808.83 (rounded off to 2 decimals)
Notes :
Cash flow If the firm has a 100 percent payout
Value of company = 4080 shares x 50 $ = 204000

b. Cash flow under the new capital structure
Shareholder cash flow
= EPS x Number of shares owned by shareholder
= (32813 / ( 4080 - 816 )) x 34000 / 50
= 6836.0416666$ = 6836.04 $ (rounded off to 2 decimals)

Note :
Number of shares raised other than debt = 0.20 x 204000 / 50 = 816 shares
Net Income = EBIT - interest
= 34853 - 0.05 (0.20 x 204000)
= 34853 - 2040
= 32813 $

c. Rebecca can maintain her current cash flow.
Number of shares shareholder to sell = 34000 x 0.2 / 50 = 136 shares
Notes :
Interest = (34000 x 0.20 / 50) x 50 x 0.05 = 340
Dividend = (32813 / ( 4080 - 816 )) x ((34000 x (1 -0.2) / 50)) = 5468.83333328
Total cash flow
= 340 + 5468.83333328
= 5808.83333328