Question

8. Homemade Leverage. 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 6,400 shares outstanding and the price per share is $55. EBIT is expected to remain at $19,300 per year forever. The interest rate on new debt is 8 percent, and there are no taxes. a. Melanie, a shareholder of the firm, owns 100 shares of stock. What is her cash flow under the current capital structure, assuming the firm has a dividend payout rate of 100 percent? b. What will Melanie's cash flow be under the proposed capital structure of the firm? Assume that she keeps all 100 of her shares. C. Suppose FCOJ does convert, but Melanie prefers the current all-equity capital structure. Show how she could unlever her shares of stock to recreate the original capital structure. d. Using your answer to part (c), explain why FCOJ's choice of capital structure is irrelevant. Ludin internrises is considering a change from its

Answer 1

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EBIT ke - Microsoft Excel (Product Activation Failed) File Home Insert Page Layout Formulas Data Review View Add-Ins - 2x * Cut Σ AutoSum : A Calibri 11 A A = = = V Wrap Text General E Copy Fill Paste B Format Painter I U B- A Merge & Center - $ -% Sort & Find & . Formatting as Table Styles 2 Clear Filter Select Clipboard Font Alignment Number Styles Cells Editing PW10970 fx PU PV PW PX PY PZ QA QB QC QD QE QE QG Q H Q3 1098 1099 1100 19300 1101 TOTAL NO OF SHARES 6400 1102 VALUE OF THE FIRM = 6400 X 55 = 352000 1103 1104 AS SHE OWNS 100 SHARES 1105 CASH FLOW = 301.56 19300*(100/6400) 1106 1107 TOTAL VALUE OF FIRM= 352000 1108 DEBT = 30% = 105600 1109 EQUITY = 246400 1110 NO OF SHARES = 246400/55 = 4480 1111 1112 19300 1113 INTEREST 8448 (105600 x 8%] 1114 EARNINGS FOR SHAREHOLDERS 10852 1115 1116 CASHFLOW 242.23 [10852 X 100/4480] RE N CONvexity DGM betaport future INDEX INTL CAP BUD LEASING PV, FV, ANNUITY DIR right clean YIELD bond portfolio cap stru WACC RESI ex div DIV POLICY NAME DIV YIELDI Rea ferences: CF135 BOU 130% O EBIT DO 4 * 4 OENG 22-11-2019

ke - Microsoft Excel (Product Activation Failed) Add-Ins Data Review View - 2x Σ AutoSum : A = = = V General File Home Insert Page Layout Formulas * Cut Calibri 11 A A E Copy Paste B Format Painter I U B- A Clipboard Font Wrap Text Merge & Center - $ -% . Fill 2 Clear Formatting as Table Styles Styles Sort & Find & Filter Select Editing Alignment Number Cells PW1136 PU PV PW QC QD QE QE QG Q H Q3 PX PY PZ QA QB when company issues 30% debt She will sell 30% of her shares & lend same at 8% interest 100 x 30% = 30 shares will be sold remaining shares = 70 so sale value of shares = 30 X 55 = 1650 INTEREST INCOME AT 8% 132 [1650 x 8%] 1118 1119 1120 1121 1122 1123 1124 1125 1126 1127 1128 1129 1130 1131 1132 1133 1134 1135 1136 RE N Rea EBIT INTEREST EARNINGS FOR SHAREHOLDERS 19300 8448 [105600 x 8%] 10852 CASHFLOW (dividend) CASHFLOW (interest) CASHFLOW 169.56 132.00 [1650 x 8%] 301.56 AS SHE EARNS SAME CASH FLOW UNDER ALL EQUITY STUCTURE AS WELL AS LEVERED STRUCTURE CAPITAL STRUCTURE IS NOT RELEVANT : CHECK ANSWER OF (a) AND (C) = 301.56 = SAME betaport future INDEX INTL CAP BUD LEASING PV, FV, ANNUITY DIR right clean YIELD bond portfolio cap stru WACC CONvexity DGM ferences: CF135 RESI ex div DIV POLICY BO B 9 . NAME 130% DIV YIELDI - . * ENG 22-11-2019