Star, Inc., a prominent consumer products firm, is debating whether or not to co
ID: 2762233 • Letter: S
Question
Star, 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 13,000 shares outstanding and the price per share is $43. EBIT is expected to remain at $72,800 per year forever. The interest rate on new debt is 6.5 percent, and there are no taxes.
Ms. Brown, a shareholder of the firm, owns 200 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 final 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 200 of her shares. (Do not round intermediate calculations and round your final 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 final 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 30 percent debt. Currently there are 13,000 shares outstanding and the price per share is $43. EBIT is expected to remain at $72,800 per year forever. The interest rate on new debt is 6.5 percent, and there are no taxes.
a.Ms. Brown, a shareholder of the firm, owns 200 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 final answer to 2 decimal places. (e.g., 32.16))
b.What will Ms. Brown’s cash flow be under the proposed capital structure of the firm? Assume that she keeps all 200 of her shares. (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
c.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 final answer to 2 decimal places. (e.g., 32.16))
Explanation / Answer
Solution:
a. Calculation of Cash flow to Ms. Brown (firm has a dividend payout rate of 100 percent)
Current Capital Structure = ALL EQUITY
Since there is not taxes & dividend payout rate is 100%, it means whatever company earn (EBIT), it will be paid to shareholders fully.
In this case, companies EBIT = $72,800
Earnings Per Share = EBIT / No. of shares outstanding = $72,800 / 13,000 = $5.60
Cash Flow to Ms. Brown who owns 200 Shares of Stock = $5.60 x 200 Shares = $1,120
b. Calculation of Cash flow to Ms. Brown under Proposed Capital structure
Proposed Capital Structure
Equity
$391,300
Debt
$167,700
$559,000
EBIT
$72,800
Less: Interest on Debt ($167,700 x 6.5%)
($10,900)
Earnings before tax
$61,900
Divide by No. of Shares outstanding
13000
EPS
$4.76
Cash Flow to Ms. Brown who owns 200 Shares of Stock = $4.76 x 200 Shares = $952
c. please clarify what does it means ----- Ms Brown unlevers here shares and re-creates the original capital structure ---- Not clear what is the meaning of this..
Proposed Capital Structure
Equity
$391,300
Debt
$167,700
$559,000
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