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FCOJ, Inc
FCOJ, Inc., a prominent consumer products firm, is debating whether or not to convert its all-equity capital structure to one that is 30 percent debt. Currently, there are 12,000 shares outstanding and the price per share is $81. EBIT is expected to remain at $57,600 per year forever. The interest rate on new debt is 6 percent, and there are no taxes.
a) Melanie, a shareholder of the firm, owns 250 shares of stock. What is her cash flow under the current capital structure, assuming the firm has a dividend payout rate of 100 percent?
b) What will Melanie's cash flow be under the proposed capital structure of the firm? Assume she keeps all 250 of her shares.
c) Assume that Melanie unlevers her shares and re-creates the original capital structure. What is her cash flow now?
Expert Solution
a) Computation of the shareholder cash flow:-
Shareholder cash flow = (EBIT / Number of shares outstanding) * Stock shares
= ($57,600 / 12,000) * 250
= $4.80 * 250
= $1,200
b) Computation of the shareholder cash flow:-
Debt issue = Total shares * Price per share * Weight of debt
= 12,000 * $81 * 30%
= $291,600
Equity issue = Total shares * Price per share * Weight of equity
= 12,000 * $81 * 70%
= $680,400
Number of equity shares = Equity issue / Price per share
= $680,400 / $81
= 8,400 shares
Revised EPS = ((EBIT-(Debt issue*Interest rate))/Number of equity shares)
= (($57,600-($291,600*6%))/8,400)
= (($57,600-$17,496)/8,400)
= $4.77
Shareholder cash flow = Revised EPS * Stock shares
= $4.77 * 250
= $1,193.57
c) Computation of the cash flow:-
Number of shares shareholder should sell = Weight of debt * Stock shares
= 30% * 250
= 75 shares
Cash flow = (Number of shares shareholder should sell*Price per share*Interest rate)+((Stock shares-Number of shares shareholder should sell)*Revised EPS)
= (75*$81*6%)+((250-75)*$4.77)
= $364.50 + $835.50
= $1,200
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