FCOJ, Inc., a prominent consumer products firm, is debating whether or not to co
ID: 2799692 • 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 5,700 shares outstanding and the price per share is $55. EBIT is expected to remain at $18,600 per year forever. The interest rate on new debt is 8 percent, and there are no taxes.
Melanie, a shareholder of the firm, owns 100 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. Round your answer to 2 decimal places (e.g., 32.16).)
What will Melanie’s cash flow be under the proposed capital structure of the firm? Assume that she keeps all 100 of her shares. (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)
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.
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 5,700 shares outstanding and the price per share is $55. EBIT is expected to remain at $18,600 per year forever. The interest rate on new debt is 8 percent, and there are no taxes.
Explanation / Answer
a) Cash flow per share = EBIT / No. of shares = 18,600 / 5,700 = $3.2632
Shareholder cash flow = $3.2632 x 100 = $326.32
b) Debt = 30% x 55 x 5,700 = $94,050
No. of shares repurchased = 30% x 5,700 = 1,710
New outstanding shares = 5,700 - 1,710 = 3,990
New cash flow per share = (EBIT - Interest) / No. of shares = (18,600 - 94,500 x 8%) / 3,990 = $2.7759
Shareholder cash flow = 100 x 2.7759 = $277.59
c) No of shares to sell = 30% x 100 = 30 shares in order to create original capital structure.
Lend 30 x 55 = 1,650 at 8%.
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