Lydic Enterprises is considering a change from its current capital structure. Th

Question

Lydic Enterprises is considering a change from its current capital structure. The company currently has an all-equity capital structure and is considering a capital structure with 30 percent debt. There are currently 4,000 shares outstanding at a price per share of $60. EBIT is expected to remain constant at $45,830. The interest rate on new debt is 12 percent and there are no taxes.

a. Rebecca owns $24,000 worth of stock in the company. If the firm has a 100 percent payout, what is her cash flow? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Shareholder cash flow $_________

b. What would her cash flow be under the new capital structure assuming that she keeps all 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 the company does convert to the new capital structure. Show how Rebecca can maintain her current cash flow. (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

Answer a No.of shares held by Rebecca = $24000 / $60 = 400 shares % of shares held by Rebecca in Lydic Enterprises = 400 shares / 4000 shares = 10% Cash flow to Rebecca = Earnings available to shareholders * % of shares held by Rebecca = $45830 * 10% = $4,583 Answer b Value of debt in a Lydic Enterprises under new capital structure = (4000 shares * $60)*30% = $72000 Revised value of equity under new Capital structure = (4000 shares * $60) - $72000 = $168000 Revised no.of shares outstanding = $168000/$60 = 2800 shares Earnings available to shareholders under new capital structure = $45830 - ($72000*12%) = $37,190 Cash flow to Rebecca under new capital structure = ($37190/2800 shares)*400 shares = $5312.86 Answer c Number of shares Rebecca should sell = Current shares held by Rebecca - [Current cash flow to Rebecca/ Earnings per share under new capital structure] Number of shares Rebecca should sell to maintain her current cash flow = 400 shares - [$4583/ $13.28] = 55 shares

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