Question

Lydic Enterprises is considering a change from its current
capital structure. The company currently has an all-equity capital
structure and is considering a capital structure with 35 percent
debt. There are currently 6,000 shares outstanding at a price per
share of $90. EBIT is expected to remain constant at $75,000. The
interest rate on new debt is 12 percent and there are no
taxes.

**a.** Rebecca owns $36,000 worth of stock in the
company. If the firm has a 100 percent payout, what is her cash
flow? **(Do not round intermediate calculations and round
your answer to 2 decimal places, e.g., 32.16.)**

Shareholder cash flow _____ $

Shareholder cash flow ______ $

Number of shares stockholder should sell ______

Answer #1

**a.** Current total capital = $90*6000 =
$540,000

Net Income = EBIT = $75,000 (As there is no interest or tax to be paid)

EPS (shareholder cash flow) = $75,000/6000 = $12.5

**Rebecca's Cash flow = ($36,000/$540,000) * $75,000 =
$5,000**

**b.** Under the new capital structure, Total
Equity = $540,000 * 0.65 = $351,000

Total Debt = $450,000 * 0.35 = $189,000

Shares Repurchased = (0.35 * 540,000)/$90 = 2100

Share Count = 6000-2100 = 3900

Net Income = EBIT - Interest = $75,000 - (12% of $189,000) = $52,320

EPS (shareholder cash flow) = $52,320/3900 = $13.41

**Rebecca's Cash flow = ($36,000/$351,000) * $52,320 =
$5366.15**

**c.** So as to maintain her cash flow, i.e.,
$5000, no. of shares she should hold = $5000/$13.41 = 372.70 i.e
373 shares

Earlier no. of shares held by Rebecca = $36,000/ $90 = 400 shares

**No. of shares Rebecca should sell = 400 - 373 = 27
shares**

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