Question: Desert Rose, Inc., a prominent consumer products firm, is debating whether to convert its all-equity capital structure to one that is 20 percent debt. Currently, there are 11,000 shares outstanding, and the price per share is $58. EBIT is expected to remain at $24,200 per year forever. The interest rate on new debt is 7.5 percent, and there are no taxes.
Part a: Allison, a shareholder of the firm, owns 200 shares of stock. What is her cash flow under the current capital structure, assuming the firm has a dividend payout rate of 100 percent?
Part b: What will Allison's cash flow be under the proposed capital structure of the firm? Assume she keeps all 200 of her shares
Part c: Assume that Allison unlevers her shares and re-creates the original capital structure. What is her cash flow now?