Climax Motors Inc.is currently all equity financed,but it is considering a leveraged capital structure,details of which are presented in the table below (under the column labeled 'Proposed') .Under the proposed capital structure,Climax will use all of the new debt to repurchase (and cancel) shares.Assume that taxes are zero.Assume that all of net income is paid out as a dividend in one year's time.Assume that the debt is perpetual with an annual coupon rate of 6%.Wolfgang von Trips owns 25,000 shares.Under each capital structure,how much does Wolfgang receive in dividends at the end of each year? Assume that Wolfgang has the same number of shares under both structures.

Question

Quizplus · Accepted Answer

Under the current, all equity capital structure (with no taxes and 100% payout policy): Total dividends = Net income, Net income = EBIT Total Dividends = EBIT = $120,000 There are 100,000 shares outstanding so von Trips is entitled to 25,000 / 100,000 = 25% of dividends. Von Trips' dividends = 0.25 × Total Dividends = 0.25 × $120,000 = $30,000 Under the proposed capital structure: Total dividends = Net income, Net income = EBIT - Interest Interest = D × k_d Total Dividends = EBIT - (D × k_d) = $120,000 - ($450,000 × 0.06) Total Dividends = $120,000 - $27,000 = $93,000 After the repurchase, there are 70,000 shares outstanding so von Trips is entitled to 25,000 / 70,000 = 35.71% of dividends. Von Trips' dividends = 0.3571 × Total Dividends = 0.3571 × $93,000 = $33,214.29