Selected financial information for Union Aerospace Corporation (UAC) is provided in the table. UAC is currently all equity financed, but it is considering a leveraged capital structure, details of which are presented in the Proposed column. Assume that UAC generates perpetual annual EBIT. Assume that all cash flows occur at the end of the year and we are currently at the beginning of a year. The company isnt growing so there are no investments in working capital or fixed assets. Assume that taxes are zero and that all of net income is paid out as a dividend. Assume that the debt is perpetual with annual coupons at the rate kD. Flynn Taggart is a shareholder in UAC. He owns 20,000 shares. Answer the questions that follow

Capital structure Current Proposed EBIT $100,000 $100,000 Debt, D $0 $285,720 Cost of Debt,kD N/A 5% Shares Outstanding 100,000 Stock price $14,286

Part 1 Under the current capital structure, how much does Flynn receive in dividends at the end of each year?

a. $40,000 b. $30,000 c. $20,000 d. $10,000

Part 2 Under the proposed capital structure, UAC will use all of the new debt to repurchase (and cancel) shares. How many shares will be left outstanding after the repurchase if UAC buys shares for $14.286 per share? a. 80,000 b. 90,000 c. 60,000 d. 70,000

Part 3

Assume that Flynn doesnt sell any shares during the repurchase. Under the leveraged capital structure, how much does Flynn receive in dividends at the end of each year?

1. $22,428
2. $20,428
3. $20,000
4. 21,429

Part 4

Assume that UAC implements the new (leveraged) capital structure and that Flynn doesnt sell any shares during the repurchase. After the repurchase, Flynn is unhappy with his dividends. How many shares does Flynn have to sell in order to return his annual cash flows to their all-equity level? (Assume that the stock price doesnt change [$14.286] and that Flynn will lend his excess cash at the same rate as UAC borrows, kD.)

1. 2,000
2. 1,000
3. 4,000
4. 3,000