Question

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Dronalution, Inc. a major drone manufacturer is currently all equity financed. They are contemplating converting all equity capital structure to one that is 30% debt, financed at 6% interest. The company currently has 5,000 shares outstanding at a price of $53 per share. EBIT is $35,000 and expected to remain at this amount. Respond to the following. Ignore taxes.

Discuss

- Mr. Fisher one of the firm's shareholders, owns 200 shares of the firm's stock. What is his cash flow under the current capital structure? Assume a dividend payout rate of 100 percent.
- What will Mr. Fisher's cash flow be under the proposed capital structure of the firm? Assume that he keeps all of his shares.
- If Dronalution does convert, but Mr. Fisher prefers the all-equity capital structure. How could he unlever his shares of stock to recreate the original capital structure?
- Explain the concept of homemade leverage and why Dronalution's choice of capital structure is irrelevant.

Answer #1

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Dronalution, Inc. a major drone manufacturer is currently all
equity financed. They are contemplating converting all equity
capital structure to one that is 30% debt, financed at 6% interest.
The company currently has 5,000 shares outstanding at a price of
$53 per share. EBIT is $35,000 and expected to remain at this
amount. Respond to the following. Ignore taxes.
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