FCOJ, Inc., a prominent consumer products firm, is debating whether or not to co
ID: 2614400 • 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 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
Explanation / Answer
a.EBIT 18,300
Less: Interest = NIL
Earning for Equity = 18,300
Number of Shares = 5400
Earning per Share = 18300/5400 = 3.388888888
Melanie has 280 shares
Dividend Payout Ratio = 100% which means that whole of EPS is distributed as dividend
Shareholder Cash Flow = 3.3888888*280 = $948.89
b.EBIT = 18,300
Less: Interest @ 8% on 82,620 = 6609.6
Earnings for Equity = 11,690.4
Number of Equity Shares = 3780
EPS = 3.0926984
Shareholder Cash Flow = EPS*280 = $865.96
Working Note: Market Value of firm = 5400*51 = 275,400
Debt issued = 30% i.e. 82,620
Equity Left 192780 i.e. 3780 shares
c.She can sell 30% of shares and buy debt from the company
Debt Acquired = 230*30%*51 = $4,284
Shares Left = 196
Cashflow = Debt = 4284*8% = 342.72
+ Equity = EPS*196 = 606.17
Total cash Flow = $948.89
Which is same as before in the all equity structure
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