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 14,000 shares outstanding and the price per share is $59. EBIT is expected to remain at $58,800 per year forever. The interest rate on new debt is 5.5 percent, and there are no taxes. a. Ms. Brown, a shareholder of the firm, owns 200 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.) Cash flow $ b. What will Ms. Brown’s cash flow be under the proposed capital structure of the firm? Assume that she keeps all 200 of her shares. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Cash flow $ c. 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.) Cash flow $

Explanation / Answer

a)Net income per share= EBIT/total shares outstanding
=58800/14000=4.2
She owns 200 shares so cash outflow is 4.2*200=840
b)under new structure
Debt to equit ratio =30%/70%=3/7
value of all equity firm=shraes outstanding*per share market
=14000*59=826000
She has to borrow 30%=30%*826000=247800
Buyback each share at 59
shares outstanding=14000-(247800/59)
=9800
net income per share=(EBIT-interest)/shares outstanding
=(58800-(247800*5.5%))/9800
=4.61
Cash flow=4.61*200=921.86

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