FCOJ, Inc., a prominent consumer products firm, is debating whether or not to co
ID: 2733102 • 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 5,100 shares outstanding and the price per share is $48. EBIT is expected to remain at $17,300 per year forever. The interest rate on new debt is 6 percent, and there are no taxes.
Melanie, a shareholder of the firm, owns 260 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. Round your answer to 2 decimal places (e.g., 32.16).)
What will Melanie’s cash flow be under the proposed capital structure of the firm? Assume that she keeps all 260 of her shares. (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)
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.
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 5,100 shares outstanding and the price per share is $48. EBIT is expected to remain at $17,300 per year forever. The interest rate on new debt is 6 percent, and there are no taxes.
Explanation / Answer
a. Current EPS = EBIT/No. of common stock
= $17300/5100
= $3.39 per share
Since dividend payout is 100% diidend will be 3.39 per share.
Thus Melanie's cash flows from dividend will be = 260 x $3.39
= $881.40
b. Current capital structure
Common stocks(5100 @ 48) = 244800
Proposed capital structure
6% Debt (30% x 244800) = 73440
Common stock(3570 x @48) = 171360
EPS = (EBIT - Interest)/No. of outstanding common stocks
= (17300 - 4406.40)/3570
= 3.61
In this case melanie's cash flow = 3.61 x 260
= 938.60
c. No. of shares to be sold = 260/5100 x 3570
= 182 shares
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