Question

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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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ke - Microsoft Excel (Product Activation Failed) File Home Insert Page Layout Formulas Data Review View Add-Ins - 2x % Cut Σ AutoSum : A Calibri -11AA = = = Dr Wrap Text General Ea Copy Fill Paste B I U B- SF A Merge Merge & Center - Center $ -% % Format Painter 4:0 .00 . Conditional Format Cell Insert Delete Format Sort & Find & Formatting as Table Styles 2 Clear Filter Select Clipboard Font Alignment Number Styles Cells Editing PZ1099 fax PU PV PW PX PY PZ QA QB QC QD QE QE QG Q H QS 1099 1100 EBIT 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 EBIT 19300 1113 INTEREST 8448 (105600 x 8%] 1114 EARNINGS FOR SHAREHOLDERS 10852 1115 1116 CASHFLOW 242.23 (10852 X 100/4480] 1117 HO N KE CAPM UTILITY, SHARPE, beta convexity DGM betaport future INDEX INTL CAP BUD LEASING PV, FV, ANNUITY DIR right clean YIELD bond portfolio cap stru WACC RESI el Rea ferences: CF670 BOI 130% - O- ...Rag m * DENG 21-11-2019

% Cut Cells ke - Microsoft Excel (Product Activation Failed) File Home Insert Page Layout Formulas Data Review View Add-Ins - 2x Σ AutoSum : A Calibri -11AA = = = Dr Wrap Text General E Copy Fill 2 m Paste BIU - D Format Painter A Merge & Center - $ % , Sort & Find & :.: Formatting as Table Styles 2 Clear Filter Select Clipboard Font Alignment Number Styles Editing PZ1117 - fx PU PV PW PX PY PZ QA QBQC QD QE QE QGQH QS 1117 1118 when company issues 30% debt 1119 She will sell 30% of her shares & lend same at 8% interest 1120 100 x 30% = 30 shares will be sold 1121 remaining shares = 70 1122 so sale value of shares = 30 X 55 = 1650 1123 INTEREST INCOME AT 8% 132 [1650 x 8%] 1124 1125 1126 EBIT 19300 1127 INTEREST 8448 (105600 x 8%] 1128 EARNINGS FOR SHAREHOLDERS 10852 1129 1130 CASHFLOW (dividend) 169.56 1131 CASHFLOW (interest) 132.00 [1650 x 8%] 1132 CASHFLOW 301.56 1133 1134 AS SHE EARNS SAME CASH FLOW UNDER ALL EQUITY STUCTURE AS WELL AS LEVERED STRUCTURE 1135 CAPITAL STRUCTURE IS NOT RELEVANT : CHECK ANSWER OF (a) AND (C) = 301.56 = SAME HARA KE CAPM UTILITY, SHARPE, beta convexity DGM beta port future INDEX INTL CAP BUD LEASING PV, FV, ANNUITY DIR right_clean_ YIELD bond portfolio cap stru WACC RESI TI Rea ferences: CF670 BO 130% - . B 9 . * ENG 21-11-2019