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Homemade leverage

Buffet enterprises is considering a change from its current capital structure. Buffet currently has an all equity capital structure and is considering a capital structure with 40% debt. There are 2,000 shares outstanding at a price per share of $100. EBIT is expected to remain constant at $29,000. the interest rate on the new debt is 7% and there are no taxes.

My problem is that if someone owns $16,000 worth of stock and the firm has 100% payout then what would the cash flow be?

Also, how would you figure out the cash flow under the new capital structure if the person keeps all their shares?

What if the company converts to the new structure and how can the person keep the same cash flow?

Solution Preview

My problem is that if someone owns $16,000 worth of stock and the firm has 100% payout then what would the cash flow be?

The present cash flow is the proportional earnings in the firm. The EBIT is $29,000 and there are 2,000 shares outstanding. Since there is not interest and taxes, the Net Income is the same as EBIT. Earnings per Share (EPS) = Net Income/Shares Outstanding
EPS = 29,000/2,000 = $14.5.
Your holding is $16,000 and price per share is ...

Solution Summary

The solution explains the use of homemade leverage when the company changes its capital structure.

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