Question

Mary owns 100 percent of a gift shop with an equity value of $150,000. If she keeps the shop open 5 days a week, EBIT is $75,000. If the shop remains open 6 days a week, EBIT increases to $92,000 annually. Mary needs an additional $50,000 which she can raise today by either selling stock or issuing debt at an interest rate of 7 percent. The principal amount would be repaid at the end of the fifth year. Ignore taxes. What will be the cash flow for this year to Mary if she issues debt, remains open 6 days a week, and distributes all the residual cash flow to the shareholders?

Multiple Choice

$81,500

$71,500

$65,000

$88,500

$46,125

Answer 1

INTEREST ON DEBT = 50000 X 7% = 3500

EBIT WILL BE 92000

RESIDUAL CASH FLOW TO SHAREHOLDERS = EBIT -INTEREST = 92000 - 3500 = 88500

Answer : $88500 [Thumbs up please]