Tom Scott is the owner, president, and primary salesperson for Scoff Manufacturi

Question

Tom Scott is the owner, president, and primary salesperson for Scoff 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? Debt issue Equity issue

Explanation / Answer

Debt Issue

Equity Issue

Tom has to work harder if he is issuing Debt because in issuing date he has to pay interest @ 7% so he has to earn more to pay the interest while issuing equity there is no interest he has to pay.

Particular 40 50 EBIT A 550000 635000 Debt Issue 1350000 1350000 Interest Rate B 7% 7% Interest A*B=C 38500 44450 Net IncomeA-C 511500 590550 Net Cash Inflow(Debt+Income) 1861500 1940550

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