Tom Scott is the owner, president, and primary salesperson for Scott Manufacturi

Question

Tom Scott is the owner, president, and primary salesperson for Scott Manufacturing. Because of this, the company's profits are driven by the amount of work Tom does. If he works 40 hours each week, the company's EBIT will be $555,000 per year, if he works a 50 hour week, the company's EBIT will be $635,000 per year. The company is currently worth $3.25 million. The company needs a cash infusion of $1.35 million, and it can issue equity or issue debt with an interest rate of 7 percent. Assume there are no corporate taxes. a. What are the cash flows to Tom under each scenario? (Enter your answers in whole dollars, not millions of dollars. Do not round intermediate calculations and round your answers to the nearest whole dollar amount. (e.g., 32)) Scenario-1 Debt issue Cash flows 40-hour week 50-hour week Scenario-2 Equity issue Cash flows 40-hour week 50-hour week

Explanation / Answer

Debt Scenario-1
40- Hour week cash flow = EBIT - Interest = 555,000 - 7%*1,350,000 = 460,500
50- Hour week cash flow = EBIT - Interest = 635,000 - 7%*1,350,000 = 540,500

Equity Issue
Incase of Equity issue share of Tom Scott = 3.25/(1.35+3.25) = 3.25/4.60
40- Hour week cash flow = EBIT * 3.25/4.60= 555,000 * 3.25/4.60= 392,119.57
50- Hour week cash flow = EBIT * 3.25/4.60= 635,000 * 3.25/4.60= 448,641.30


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