Dronalution, Inc. a major drone manufacturer is currently all equity financed. They are contemplating converting all equity capital structure to one that is 30% debt, financed at 6% interest. The company currently has 5,000 shares outstanding at a price of $53 per share. EBIT is $35,000 and expected to remain at this amount. Respond to the following. Ignore taxes.
Mr. Fisher one of the firm’s shareholders, owns 200 shares of the firm’s stock. What is his cash flow under the current capital structure? Assume a dividend payout rate of 100 percent.
What will Mr. Fisher’s cash flow be under the proposed capital structure of the firm? Assume that he keeps all of his shares.
If Dronalution does convert, but Mr. Fisher prefers the all-equity capital structure. How could he unlever his shares of stock to recreate the original capital structure?
Explain the concept of homemade leverage and why Dronalution’s choice of capital structure is irrelevant.