Homemade Leverage. Petty Enterprises is considering a change from its current capital structure. Petty currently has an all-equity capital structure and is considering a capital structure with 30 percent debt. There are currently 3,000 shares outstanding at a price per share of $80. EBIT is expected to remain constant at $34,500. The interest rate on new debt is 7 percent and there are no taxes.
a. Rebecca owns $20,000 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/ he 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 Petty"s choice of capital structure is irrelevant.
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