Question

FCOJ, Inc., a prominent consumer products firm, is debating whether to convert its all-equity capital structure to one that is 30 percent debt. Currently, there are 7,000 shares outstanding, and the price per share is $44. EBIT is expected to remain at $30,100 per year forever. The interest rate on new debt is 9 percent, and there are no taxes.

-Allison, a shareholder of the firm, owns 150 shares of stock. What is her cash flow under the current capital structure, assuming the firm has a dividend payout rate of 100 percent?

-What will Allison’s cash flow be under the proposed capital structure of the firm? Assume she keeps all 150 of her shares.

-Assume that Allison unlevers her shares and re-creates the original capital structure. What is her cash flow now?

Answer 1