FIN 620 Session 5 Homework Assignment Answers

# FIN 620 Session 5 Homework Assignment Answers - FIN 620...

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FIN 620 Session 5 Homework Assignment Answers: Session 5: Do problems 17-2 and 17-6 2. a. Debt issue: The company needs a cash infusion of \$1.2 million. If the company issues debt, the annual interest payments will be: Interest = \$1,200,000(.08) = \$96,000 The cash flow to the owner will be the EBIT minus the interest payments, or: 40 hour week cash flow = \$400,000 – 96,000 = \$304,000 50 hour week cash flow = \$500,000 – 96,000 = \$404,000 Equity issue: If the company issues equity, the company value will increase by the amount of the issue. So, the current owner’s equity interest in the company will decrease to: Tom’s ownership percentage = \$2,500,000 / (\$2,500,000 + 1,200,000) = .68 So, Tom’s cash flow under an equity issue will be 68 percent of EBIT, or: 40 hour week cash flow = .68(\$400,000) = \$270,270 50 hour week cash flow = .68(\$500,000) = \$337,838 b. Tom will work harder under the debt issue since his cash flows will be higher. Tom will gain more under this form of financing since the payments to bondholders are fixed. Under an equity

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## This note was uploaded on 02/14/2011 for the course FINANCE 620 taught by Professor Halstead during the Fall '09 term at UMBC.

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FIN 620 Session 5 Homework Assignment Answers - FIN 620...

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