Tom Scott is the owner, president, and primary salesperson for Scott Manufacturi
ID: 2648399 • Letter: T
Question
Tom Scott is the owner, president, and primary salesperson for Scott Manufacturing. Because of this, the company?s profits are driven by the amount of work Tom does. If he works 40 hours each week, the company?s EBIT will be $555,000 per year; if he works a 50 hour week, the company's EBIT will be $635.000 per year. The company is currently worth $3.25 million. The company needs a cash infusion of $1.35 million, and it can issue equity or issue debt with an interest rate of 7 percent. Assume there are no corporate taxes. a. What are the cash flows to Tom under each scenario? (Enter your answers in whole dollars, not millions of dollars. Do not round intermediate calculations and round your answers to the nearest whole dollar amount. (e.g., 32)) b. Under which form of financing is Tom likely to work harder?Explanation / Answer
a. Calculation of cash flows Scenario 1 (Debt issue) 40 Hours Per week 50 Hours Per week EBIT $ 555,000 $ 635,000 Less: Interest $ (91,000) $ (91,000) (1300000*7%) Cash flows $ 464,000 $ 544,000 Scenario 2 (Equity issue) 40 Hours Per week 50 Hours Per week EBIT $ 555,000 $ 635,000 Less: Interest $ - $ - Cash flows $ 555,000 $ 635,000 b. Tom is likely to work harder under Equity issue