Question

FCOJ, Inc., a prominent consumer products firm, is debating whether or not to convert its all-equity capital structure to one that is 40 percent debt. Currently, there are 5,500 shares outstanding and the price per share is $52. EBIT is expected to remain at $19,100 per year forever. The interest rate on new debt is 7 percent, and there are no taxes.

a. Melanie, a shareholder of the firm, owns 270 shares of stock. What is her cash flow under the current capital structure, assuming the firm has a dividend payout rate of 100 percent?

Answer 1

FCOJ, Inc.,
Current D/E: 100% Equity -> D/E = 0; V = 5,500 × $52 = $286,000
Proposed D/E: 40% Debt; 60% Equity -> D/E = 0.4/0.6 = 0.67
EBIT = 19,100 forever; Rd = 7%; Tc = 0%
a. Melanie, a shareholder of the firm, owns 270 shares of stock. What is her cash flow under the
current capital structure, assuming the firm has a dividend payout rate of 100 percent?
NI / #Shares = 19100 / 5500 = $3.47 / share
Payout = 100% -> $3.47 x 270 Shares = $936.90