Seether, Inc., a prominent consumer products firm, is debating whether to conver
ID: 2629099 • Letter: S
Question
Seether, Inc., a prominent consumer products firm, is debating whether to convert its all-equity capital structure to one that is 39 percent debt. Currently, there are 2,400 shares outstanding, and the price per share is $75. EBIT is expected to remain at $15,000 per year forever. The interest rate on new debt is 9 percent, and there are no taxes.
Required : (a) Allison, a shareholder of the firm, owns 100 shares of stock. Her cash flow is how much under the current capital structure, assuming the firm has a dividend payout rate of 100 percent? (Do not include the dollar sign ($). Round your answers to 2 decimal places. (e.g.,16.32))
(b) Allison's cash flow will be how much under the proposed capital structure of the firm. Assume she keeps all 100 of her shares.(Do not include the dollar sign ($). Round your answers to 2 decimal places. (e.g.,16.32))
(c) Suppose the company does convert, but Allison prefers the current all-equity capital structure. She could unlever her shares of stock to recreate the original capital structure by selling how many shares of stock and lending the proceeds at 9 percent?
Explanation / Answer
a. The earnings per share are:
EPS = $15,000/2,400 shares
EPS = $6.25
So, the cash flow for the company is:
Cash flow = $6.25(100 shares)
Cash flow = $625
b. To determine the cash flow to the shareholder, we need to determine the EPS of the firm under the proposed capital structure. The market value of the firm is:
V = $75(2,400)
V = $180,000
Under the proposed capital structure, the firm will raise new debt in the amount of:
D = 0.39($180,000)
D = $70,200
in debt. This means the number of shares repurchased will be:
Shares repurchased = $70,200/$75
Shares repurchased = 936
Under the new capital structure, the company will have to make an interest payment on the new debt. The net income with the interest payment will be:
NI = $15,000