M&M Proposition 1: Dynamo Corp produces annual cash flows of $150 and is expecte

Question

M&M Proposition 1: Dynamo Corp produces annual cash flows of $150 and is expected to exist forever. The company is currently financed with 75 percent equity and 25 percent devt. Your analysis tells you taht the appropriate discount rates are 10 percent for the cash flows, and 7 percent for the debt. You currently own 10 percent of the stock. If Dynamo wishes to change its capital structure from 75 to 60 percent equity and use the debt proceeds to apy a special dividend to shareholdrs, how much debt should they use?

Explanation / Answer

cash flow worth =150*0.06/0.1 =900

for debt = 900*(1-3/4)

=$225

they must issue $225 as debt

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