FCOJ, Inc., a prominent consumer products firm, is debating whether or not to co
ID: 2797460 • 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 30 percent debt. Currently, there are 5,400 shares outstanding and the price per share is $51. EBIT is expected to remain at $18,300 per year forever. The interest rate on new debt is 8 percent, and there are no taxes. a. Melanie, a shareholder of the firm, owns 280 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 280 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) EBIT = 18,300
There are no taxes. Also, capital structure under current scenerio is 100% equity. Therefore, No interest cost.
EBIT = EAT (Earnings after Tax) = 18,300
EPS = 18300 / 5400 = $3.39 per share.
Therefore Melanie will receive = 3.39 x 280shares = $ 949.20
b) Received capital structure
Debt = 30% of Capital Employeed
=30% of Equity Value = 30% x (5400 x 51)
=$ 82,620
No of shares converted to debt = 5400 x 30 % = 1620
No of share outstanding in revised capital structure = 5400-1620 = 3780
Interest expense on Debt = 82620 x 8% = 6610
EBIT = 18300
EBT = EAT = 18300 - 6610 = $ 11690
Therefore EPS = 11690 / 3780 = 3.09
Therefore Melanie will receive = 3.09 x 280shares = $ 865.20
(c) to create earlier capital structure:
Leverage Ratio = EBIT / EBT = 18300 / 11690 = 1.565
Therefore, Melanie should sell = 280 - (280/1.565) = 101 shares.
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