Staal Enterprises is considering a change from its current capital structure. St
ID: 2769344 • Letter: S
Question
Staal Enterprises is considering a change from its current capital structure. Staal currently has an all-equity capital structure and is considering a capital structure with 25 percent debt. There are currently 6,100 shares outstanding at a price per share of $60. EBIT is expected to remain constant at $38,000. The interest rate on new debt is 7 percent and there are no taxes. Required: (a) Rebecca owns $18,000 worth of stock in the company. If the firm has a 100 percent payout, what is her cash flow? (Do not round intermediate calculations. 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. 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. Number of shares stockholder should sell
Explanation / Answer
(a) Computation of the shareholder cash flow under existing capital structure.We have,
Total value of the firm = Market price per share x Number of shar outstanding
Total value of the firm = 60 x 6,100 = $ 366,000
EBIT = $ 38,000
Shareholder Cash inflow for $ 18,000 worth of stock = 38,000 x 18,000/366,000 = $ 1,868.85
(b) Computation of the shareholder cash flow under new capital structure.We have,
Value of debt = 366,000 x 25% = $ 91,500
Interest on debt = 91,500 x 7% = $ 6,405
EBT = EBIT - Interest
EBT = 38,000 - 6,405 = $ 31,595
Share repurchase after introducing debt = 91,500/60 = 1,525 shares
Net shares after introducing debt = 6,100 - 1,525 = 4,575 shares
Earning per share = EBT / Total number of shares
Earning per share = 31,595 / 4,575 = $ 6.91
Shareholder cash flow = (18,000/60) x 6.91 = $ 2,073
(c) Extra earning = 2,073 - 1,868.85 = $ 204.15
Number of share should sell to maintain current cash flow =Extra Earning/Number of shares
= 204.15/6.91 = 29.54 shares
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