Bruno's is considering changing from its current all-equity capital structure to 30 percent debt.There are currently 7,500 shares outstanding at a price per share of $39.EBIT is expected to remain constant at $23,000.The interest rate on new debt is 7.5 percent and there are no taxes.Tracie owns $12,675 worth of stock in the company.The firm has a 100 percent payout.What would Tracie's cash flow be under the new capital structure assuming that she keeps all of her shares?
A)$998
B)$1,109
C)$1,115
D)$1,037
E)$1,016

Question

Quizplus · Accepted Answer

Under the new capital structure, the firm will have interest expenses. The interest expense is 30% of the firm's value ($292,500) at 7.5%, which is $6,570. EBIT is $23,000, so the earnings after interest is $16,430. With 100% payout, Tracie's cash flow is her proportion of the earnings, which is ($12,675 / $292,500) * $16,430 = $1,016.

Bruno's Is Considering Changing from Its Current All-Equity Capital Structure