Question

Pagemaster 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 10,560 shares outstanding at a price per share of $50. EBIT is expected to remain constant at $60,696. The interest rate on new debt is 5 percent and there are no taxes. |

a. |
Rebecca owns $22,000 worth of stock in the company. If the firm
has a 100 percent payout, what is her cash flow? |

b. |
What would her cash flow be under the new capital structure
assuming that she keeps all of her shares? (Do not round
intermediate calculations and round your answer to 2 decimal
places, 32.16.) |

c. |
Suppose the company does convert to the new capital structure.
Show how Rebecca can maintain her current cash flow. (Do
not round intermediate calculations and round your answer to 2
decimal places, 32.16.) |

Answer #1

a). Value of Company = Share Price * Shares Outstanding = $50 * 10,560 = $528,000

Rebecca's Cash flow = [Rebecca Ownership / Value of Company] * Net Income

= [$22,000 / $528,000] * $60,696 = 0.0417 * $60,696 = $2,529

b). Shares Repurchased = [Value of Company * wD] / Current Share Price

= [$528,000 * 0.35] / $50 = 3,696

Net Income = EBIT - Interest

= $60,696 - [($528,000 * 0.35) * 0.05]

= $60,696 - $9,240 = $51,456

EPS = Net Income / [Current Share Outstanding - Share Repurchased]

= $51,456 / [10,560 - 3,696] = $51,456 / 6,864 = $7.50

Shares Owned by Rebecca = Rebecca's Ownership / Current Share Price = $22,000 / $50 = 440

Rebecca's Cash Flow = Shares Owned by Rebecca * EPS = 440 * $7.50 = $3,298.46

c). X = Shares Sold

[(Rebecca's Shares - Shares Sold) * EPS] + [Interest Rate * Current Share Price * Shares Sold] = Current Cash Flow

[(440 - X) * $7.50] + [0.05 * $50 * X] = $2,529

$3,298.46 - [X * $7.50] + [X * $2.50] = $2,529

[X * $5.00] = $3,298.46 - $2,529

X = $769.46 / $5.00 = 154 shares

She can sell 154 shares and put the money into an account that earns interest at 5%

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