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 30 percent debt. There are currently 2,150 shares outstanding at a price per share of $70. EBIT is expected to remain constant at $20,000. The interest rate on new debt is 10 percent and there are no taxes.

a. Rebecca owns $30,100 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            $

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. Value of company is computed as follows:

= 2,150 shares x $ 70

= $ 150,500

Rebecca cash flow will be:

= $ 30,100 / $ 150,500 x $ 20,000

= $ 4,000

b. Rebecca cash flow will be:

Shares repurchased is computed as follows:

= ( 0.30 x $ 150,500 ) / $ 70

= 645

Net Income will be

= $ 20,000 - 0.10 ( 0.30 x $ 150,500 )

= $ 15,485

EPS will be as follows:

= $ 15,485 / ( 2,150 - 645 )

= $ 10.29 Approximately

Shares owned = $ 30,100 / $ 70

430 shares

So the cash flow will be:

= 430 shares x $ 10.29

= $ 4,424.7

c. Let number of shares to be sold be Y

( 430 - Y ) x 10.29 + 0.10 x $ 70 x Y = $ 4,000

= $ 68 Approximately

Feel free to ask in case of any query relating to this question