FCOJ, Inc., a prominent consumer products firm, is debating whether or not to co
ID: 2794307 • 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 35 percent debt. Currently, there are 5,900 shares outstanding and the price per share is $65. EBIT is expected to remain at $24,485 per year forever. The interest rate on new debt is 10 percent, and there are no taxes.
a. Melanie, a shareholder of the firm, owns 240 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.)
Shareholder cash flow $
b. What will Melanie’s cash flow be under the proposed capital structure of the firm? Assume that she keeps all 240 of her shares. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
Shareholder cash flow $
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. (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)
Number of shares stockholder should sell
Explanation / Answer
a) EPS = EBIT / No. of shares = 24,485 / 5,900 = $4.15
Shareholder's cash flow = 240 x 4.15 = $996
b) Value of firm = No. of shares x Share Price = 65 x 5,900 = $383,500
Debt = 35% x 383,500 = 134,225
No. of shares repurchased = 134,225 / 65 = 2,065
New outstanding shares = 5,900 - 2,065 = 3,835
New EPS = (EBIT - Interest) / No. of shares = (24,485 - 134,225 x 10%) / 3,835 = $2.885
Shareholder Cash Flows = 2.885 x 240 = $692.31
c) In order to recreate the original capital structure, she should sell 35% of shares and lend it back at 10% to the firm.
No. of shares to sell = 35% x 240 = 84 shares.
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