FCOJ, Inc., a prominent consumer products firm, is debating whether or not to co
ID: 2476923 • Letter: F
Question
FCOJ, Inc., a prominent consumer products firm, is debating whether or not to convert its all-equity capital structure to one that is 35 percent debt. Currently, there are 6,900 shares outstanding and the price per share is $59. EBIT is expected to remain at $26,220 per year forever. The interest rate on new debt is 10 percent, and there are no taxes.
Melanie, a shareholder of the firm, owns 180 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. Round your answer to 2 decimal places (e.g., 32.16).)
What will Melanie’s cash flow be under the proposed capital structure of the firm? Assume that she keeps all 180 of her shares. (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)
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.
Required:Explanation / Answer
Answer:(a) EPS=Net income/Shares=26220/6900=$3.8 per share
The cash flow for the company is:
Cash flow=$3.8*180 shares=$684
Answer:(b) To determine the cash flow to the shareholder, we need to determine the EPS of the firm under the proposed capital structure. The market value of the firm is:
V = $59(6900)
V = $4071,00
Under the proposed capital structure, the firm will raise new debt in the amount of:
D = 0.35($4071,00)
D = $142485
in debt. This means the number of shares repurchased will be:
Shares repurchased = $142485/$59
Shares repurchased = 2415
Under the new capital structure, the company will have to make an interest payment on the new debt. The net income with the interest payment will be:
NI = $26,220 – .10($142485)
NI =$11971.5
This means the EPS under the new capital structure will be:
EPS = $11971.5/4485 shares
EPS = $2.67 per share
Since all earnings are paid as dividends, the shareholder will receive:
Shareholder cash flow = $2.67(180 shares)
Shareholder cash flow = $480.6
Answer:(c) the shareholder should sell 35 percent of their shares.
180*35%=63 share
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