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? (Do not round intermediate calculations and round your answer to 2 decimal places, 32.16.)
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%