Star, Inc., a prominent consumer products firm, is debating whether or not to co

Question

Star, Inc., a prominent consumer products firm, is debating whether or not to convert its all-equity capital structure to one that is 20 percent debt. Currently there are 6,000 shares outstanding and the price per share is $60. EBIT is expected to remain at $23,400 per year forever. The interest rate on new debt is 5 percent, and there are no taxes.

Ms. Brown, a shareholder of the firm, owns 150 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.)

What will Ms. Brown’s cash flow be under the proposed capital structure of the firm? Assume that she keeps all 150 of her shares. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Assume that Ms. Brown unlevers her shares and re-creates the original capital structure. What is her cash flow now? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Star, Inc., a prominent consumer products firm, is debating whether or not to convert its all-equity capital structure to one that is 20 percent debt. Currently there are 6,000 shares outstanding and the price per share is $60. EBIT is expected to remain at $23,400 per year forever. The interest rate on new debt is 5 percent, and there are no taxes.

Explanation / Answer

Current Proposed 5% Debt 0 20% Equity 100% 80% Debt Equity Ratio                   -                     0.25 Shares            6,000                4,800 Value of the sahres      3,60,000          2,88,000 Debt              72,000 EBIT          23,400              23,400 Interest                3,600 Taxes 0 0 PAT          23,400              19,800 EPS 3.9 4.125 Current (a) Proposed (b) No of shares 150 150 EPS 3.9 4.125 Earning on 150 shares 585.00 618.75 If She keep porposed capital stucture So she will convert 20% of 150*60 into debt=1800 no of equity shares will be with him= 150*80%=120 Return on 1800*5%= 90 Retunr on equity =120*4.125 495 Total retunr same as in original capital structure 585.00

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