Question

FCOJ, Inc., a prominent consumer products firm, is debating whether or not to convert its all-equity capital structure to one that is 30 percent debt. Currently there are 7,000 shares outstanding and the price per share is $44. EBIT is expected to remain at $30,100 per year forever. The interest rate on new debt is 9 percent and there are no taxes. a. Ms. Brown, a shareholder of the firm, owns 150 shares of stock. What is her cash flow under the current capital structure, assuming the firm has a dividend payout rate of 100 percent? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) b. What will Ms. Brown’s cash flow be under the proposed capital structure of the firm? Assume that she keeps all 150 of her shares. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) c. Assume that Ms. Brown unlevers her shares and re-creates the original capital structure. What is her cash flow now?

Answer 1

	FCOJ, Inc.
	Number of shares outstanding	7000
	Price per share	44
	Total debt	30%
	EBIT	30100
	Interest rate on a new debt	9%
a)	MS.Brown holds number of shares	150
	Dividend payout rate	100%
	EPS=(EBIT/Number of shares outstanding)=($30100/7000)=	$               4.30
	Cash flow for the Company=(EPS*Number of shares)=(4.3*150)	$           645.00
b)	Market value of a firm under proposed capital structure
	Value of a firm=(Number of shares outstanding* Price per share)=(7000*$44)	$ 3,08,000.00
	Company raise new debt=(Value of a firm* Total debt)=($308000*40%)	92400
	Number of shares repurchased=($924000/$44)	2100
	Interest Paid on new debt=($92400*9%)	$       8,316.00
	Net Income=(EBIT-Interest)=($30100-$8316	$     21,784.00
	Number of shares outstanding=(7000-2100)=	4900
	EPS=($21784/4900)=	$               4.45
	All earnings are paid as dividend shareholder cash flow=(150*$4.445)	$           666.86
c )	Interest cash flow=(shares*Price per share*Interest rate)=(150*30%*$44*9%)	$           178.20
	Dividend received on 70% shares=(105*$4.445)	$           266.74
	Total cash flow	$           444.94