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 20 percent debt. There are currently 4,080 shares outstanding at a price per share of $50. EBIT is expected to remain constant at $34,853. The interest rate on new debt is 5 percent and there are no taxes.

a. Rebecca owns $34,000 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

a) Rebecca has shares = 34,000 / 50 = 680

Shareholder Cash flow = (34,853 / 4080) x 680 = 5,808.83

b) Firm Value = 4,080 x 50 = 204,000

Debt = 20% x 204,000 = 40,800 and Equity = 80% x 204,000 = 163,200

No. of shares repurchased = 40,800 / 50 = 816. New outstanding shares = 4,080 - 816 = 3,264

Cash flow = (EBIT - Interest) / Outstanding shares x Rebecca's share = (34,853 - 5% x 40,800) / 4080 x 680 = $5,468.83

c) In order to maintain her cash flow, Rebecca should sell 20% shares and lend the amount at 5% rate

No. of shares to sell = 20% x 680 = 136

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