Answer:
The related cash flows to Sean are as follows;
a. $424,000
b. $592,000
c.$399,808
d. $512,885
Explanation:
In this question, we are asked to calculate cash flows to Davis manufacturing given that debt is issues and equity is issued for a number of hour-week
We proceed as follows;
a. For a 40 - hour week and Debt is issued
Mathematically, the cash flow is calculated below as follows;
Cash Flow = EBIT - Interest on debt = $594,000 - ($1.7 million x 10%) = $424,000
b. For a 50 - hour week and Debt is issued
Mathematically, the cash flow is calculated as follows;
Cash Flow = EBIT - Interest on debt = $762,000 - ($1.7 million x 10%) = $592,000
c. For a 40 - hour week and Equity is issued
Mathematically, the cash flow is calculated as follows;
In this case, there will be no interest cost
The firm's value will be increased by the amount of infusion but ownership of sean will be diluted.
New ownership of Sean = $3.5 million / ($3.5 million + $1.7 million) = 0.67307692307
Mathematically, the cash flow is calculated as follows
Cash Flow to Sean = EBIT x new share = $594,000 x 0.67307692307 = $399,808
d. For a 50 - hour week and Equity is issued
The calculation is as above and there is also no interest course
Cash Flow = EBIT x new share = $762,000 x 0.67307692307 = $512,885
KINDLY NOTE EBIT IS EARNINGS BEFORE INTEREST AND TAXES
