Staal Enterprises is considering a change from its current capital structure. St

Question

Staal Enterprises is considering a change from its current capital structure. Staal currently has an all-equity capital structure and is considering a capital structure with 35 percent debt. There are currently 6,500 shares outstanding at a price per share of $50. EBIT is expected to remain constant at $89,856. The interest rate on new debt is 6 percent and there are no taxes.

Rebecca owns $10,000 worth of stock in the company. If the firm has a 100 percent payout, what is her cash flow? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)

What would her cash flow be under the new capital structure assuming that she keeps all of her shares? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)

Suppose the company does convert to the new capital structure. Show how Rebecca can maintain her current cash flow.

Staal Enterprises is considering a change from its current capital structure. Staal currently has an all-equity capital structure and is considering a capital structure with 35 percent debt. There are currently 6,500 shares outstanding at a price per share of $50. EBIT is expected to remain constant at $89,856. The interest rate on new debt is 6 percent and there are no taxes.

Explanation / Answer

Cash flow = $13.82 per share

Cash flow for Rebecca ($13.82 x $10000)=$138200

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 = $50(6500)

V = $325000

Under the proposed capital structure, the firm will raise new debt in the amount of:

D = 0.35($325,000)

D = $113750

in debt. This means the number of shares repurchased will be:                    

Shares repurchased = $113750/$50 = $2275

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 = $89856 – 0.06($113750) = 83031

This means the EPS under the new capital structure will be:

EPS = $83031/$4225 (Share outstanding - share repurchased) = $19.65 shares

Since all earnings are paid as dividends, the Rebecca will receive:

Rebecca cash flow = $19.65 x $10000 = $196523

Rebecca EPS EBIT $89,856 Net Income $89,856 Number of Shares Outstanding 6,500 EPS (net income / average outstanding common shares) $13.82

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