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 5,400 shares outstanding and the price per share is $51. EBIT is expected to remain at $18,300 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 280 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.)
  
Shareholder cash flow            $

b. What will Melanie’s cash flow be under the proposed capital structure of the firm? Assume that she keeps all 280 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 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. (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. Melanie, a shareholder of the firm, owns 280 shares of stock. What is her cash flow under the current capital structure, assuming the firm has a dividend payout rate of 100 percent?

Earnings per share
$18300/5400 shares	$                         3.39
Dividends are paid through all earnings, the cash flow for the investor will be
Cash flow:	$3.29 (280 shares)
	$                     921.20

b. What will Melanie’s cash flow be under the proposed capital structure of the firm? Assume that she keeps all 280 of her shares

V = $51 * 5400 Shares
$                    2,75,400
Under proposed capital, the firm's new debt will raise to
D = 0.30*$275400
D = $82620
Number of shares to be repurchased
$82620/$51
1620 shares
Under new capital structure, the company will have to make an interest payment on the new debt
The net income with interest will be
Net income :
$18,300 - 0.08($82620)
$11,690
EPS under new capital structure will be
$11690/(5400-1620)
$3.09
Dividends are paid through all earnings, the cashflow for the investor will be
$3.09* 280 shares
$865.20 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. 280 shares *30 % 84 shares