FCOJ, Inc., a prominent consumer products firm, is debating whether or not to co
ID: 2719782 • 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 40 percent debt. Currently, there are 6,500 shares outstanding and the price per share is $57. EBIT is expected to remain at $22,750 per year forever. The interest rate on new debt is 6 percent, and there are no taxes.
Melanie, a shareholder of the firm, owns 130 shares of stock. What is her cash flow under the current capital structure, assuming the firm has a dividend payout rate of 100 percent?
What will Melanie’s cash flow be under the proposed capital structure of the firm? Assume that she keeps all 130 of her shares.
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.
Number of shares stockholder should sell ____
FCOJ, Inc., a prominent consumer products firm, is debating whether or not to convert its all-equity capital structure to one that is 40 percent debt. Currently, there are 6,500 shares outstanding and the price per share is $57. EBIT is expected to remain at $22,750 per year forever. The interest rate on new debt is 6 percent, and there are no taxes.
Explanation / Answer
(a)Melanie, a shareholder of the firm, owns 130 shares of stock. What is her cash flow under the current capital structure, assuming the firm has a dividend payout rate of 100 percent?
Dividend Per share = 22750/6500
Dividend Per share = 3.50
Shareholder cash flow = Dividend Per share*No of share
Shareholder cash flow = 3.5*130
Shareholder cash flow = $ 455
b)What will Melanie’s cash flow be under the proposed capital structure of the firm? Assume that she keeps all 130 of her shares.
Value of Unlevered Firm = 57*6500 = 370500
Since there is no tax rate
Value of levered firm = Value of Unlevered Firm
Value of levered firm = 370500
Debt = 40%*370500 = 148200
Equity = 60%*370500 = 222300
No of Common Stock Outstanding = 222300/57 = 3900
Dividend Per Share = (EBIT-Interest -Retention Amount)/No of Common Stock Outstanding
Dividend Per Share =( 22750 - 148200*6% - 0)/3900
Dividend Per Share = 3.5533
Shareholder cash flow = Dividend Per Share * No of share
Shareholder cash flow = 3.5533*130
Shareholder cash flow = $ 462
(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.
Number of shares stockholder should sell = 130 * (6500-3900)/6500
Number of shares stockholder should sell = 52
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