Star, Inc., a prominent consumer products firm, is debating whether or not to co

Question

Star, 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 18,000 shares outstanding and the price per share is $49. EBIT is expected to remain at 563,000 per year forever. The interest rate on new debt is 10 percent, and there are no taxes. Ms. Brown, a shareholder of the firm, owns 250 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 and round your answer to 2 decimal places, e.g., 32.16.) What will Ms. Brown's cash flow be under the proposed capital structure of the firm Assume that she keeps all 250 of her shares. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Assume that Ms. Brown unlevers her shares and re-creates the original capital structure. What is her cash flow now (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Explanation / Answer

a)% Of holding by brown = 250 / 18000 = 1.3889%

Cash flow = 63000 * .013889 = $ 875

b) Debt raised = 18000 *49 * .30 = 264600

Equity = 18000 *49 *.70 = 617400

Number of shares outstanding after debt issue= 617400/49 = 12600shares

Earning after interest = 63000 - (264600* .10)

                          = 63000- 26460 = $ 36540

cash flow to brown = 36540 * 250 / 12600 = $ 725

c) Number of shares given up = 250 * .30 = 75 shares

Debt taken = 75 * 49 = 3675

Interest received = 3675 * .10 = 367.5

remaining shares = 250 -75 = 175

Dividend = 36540 *175 / 12600 = 507.5

Total cash flow = 507.5 + 367.5 = 875

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