Question: Homemade Leverage. Lydic Enterprises is considering a change from its current capital structure. The company currently has an all-equity capital structure and is considering a capital structure with 25 percent debt. There are currently 6,400 shares outstanding at a price per share of $60. EBIT is expected to remain constant at $47,000. The interest rate on new debt is 7 percent and there are no taxes.
a. Rebecca owns $18,000 worth of stock in the company. If the firm has a 100 percent payout, what is her cash flow?
b. What would her cash flow be under the new capital structure assuming that she keeps all of her shares?
c. Suppose the company does convert to the new capital structure. Show how Rebecca can maintain her current cash flow.
d. Under your answer to part (c), explain why the company's choice of capital structure is irrelevant.