Conspicuous Consumption, Inc., a prominent consumer products firm, is debating w

Question

Conspicuous Consumption, Inc., a prominent consumer products firm, is debating whether to convert its all-equity capital structure to one that is 43 percent debt. Currently, there are 2,100 shares outstanding and the price per share is $ 75. EBIT is expected to remain at $ 16,000 per year forever. The interest rate on new debt is 8 percent, and there are no taxes.

Ms. Brown, a shareholder of the firm, owns 100 shares of stock. Her cash flow is $under the current capital structure, assuming the firm has a dividend payout rate of 100 percent.(Do not include the dollar sign ($).Round your answers to 2 decimal places. (e.g.,16.32))

Ms. Brown

Conspicuous Consumption, Inc., a prominent consumer products firm, is debating whether to convert its all-equity capital structure to one that is 43 percent debt. Currently, there are 2,100 shares outstanding and the price per share is $ 75. EBIT is expected to remain at $ 16,000 per year forever. The interest rate on new debt is 8 percent, and there are no taxes.

Explanation / Answer

The earnings per share are:

EPS = €16,000/2,100 shares

EPS = €7.61

So, the cash flow for the company is:

Cash flow = €7.61 (100 shares)

Cash flow = €761

==============================

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 = 75(2,100)

V =157500

Under the proposed capital structure, the

firm will raise new debt in the amount of:

D = 0.43(157500)

•D = 67725

in debt. This means the number of shares

repurchased will be:

•Shares repurchased = 67725/70

Shares repurchased = 967.5

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