Star, Inc., a prominent consumer products firm, is debating whether or not to convert its all-equity capital structure to one that is 50 percent debt. Currently there are 1,000 shares outstanding and the price per share is $65. EBIT is expected to remain at $37,500 per year forever. The interest rate on new debt is 8 percent, and there are no taxes.
1. Ms. Brown, a shareholder of the firm, owns 100 shares of stock. What is her cash flow under the current capital structure, assuming the firm has a dividend payout rate of 100 percent?
2. What will Ms. Brownâs cash flow be under the proposed capital structure of the firm? Assume that she keeps all 100 of her shares?
3. Suppose Star does convert, but Ms. Brown prefers the current all-equity capital structure. Show how she could unlever her shares of stock to recreate the original capital structure.
4.Using your answer to part (c), explain why Starâs choice of capital structure is irrelevant.
Star, Inc., a prominent consumer products firm, is debating whether or not to convert its all-equity capital structure to one that is 50 percent debt. Currently there are 1,000 shares outstanding and the price per share is $65. EBIT is expected to remain at $37,500 per year forever. The interest rate on new debt is 8 percent, and there are no taxes.
1. Ms. Brown, a shareholder of the firm, owns 100 shares of stock. What is her cash flow under the current capital structure, assuming the firm has a dividend payout rate of 100 percent?
2. What will Ms. Brownâs cash flow be under the proposed capital structure of the firm? Assume that she keeps all 100 of her shares?
3. Suppose Star does convert, but Ms. Brown prefers the current all-equity capital structure. Show how she could unlever her shares of stock to recreate the original capital structure.
4.Using your answer to part (c), explain why Starâs choice of capital structure is irrelevant.
Related questions
| 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 6,500 shares outstanding and the price per share is $57. EBIT is expected to remain at $22,750 per year forever. The interest rate on new debt is 6 percent, and there are no taxes. |
| Required: |
| (a) | Melanie, a shareholder of the firm, owns 130 shares of stock. What is her cash flow under the current capital structure, assuming the firm has a dividend payout rate of 100 percent?
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| b) | What will Melanieâs cash flow be under the proposed capital structure of the firm? Assume that she keeps all 130 of her shares. |
| Shareholder cash flow | $ ___ |
| (c) | Suppose FCOJ does convert, but Melanie prefers the current all-equity capital structure. Show how she could unlever her shares of stock to recreate the original capital structure. Number of shares stockholder should sell ____ |
