ABC company is an All-Equity firm with total equity shares outstanding equal to 100,000. The company is expecting an EBIT of $600,000. Share price is $7.00 The company has a 100% payout ratio. The company has been considering changing its capital structure to include debt with a D/E ratio of 1.2 which would include an interest rate equal to 10%.
If the company remains an All-equity firm but a shareholder wishes a cash flow similar to the proposed leverage capital structure (D/E = 1.2) show how he can use the HomeMade Leverage strategy to get that cash flow. You can ignore taxes. (Assume he wants to duplicate an investment of 1000 shares in the proposed levered firm)
You must show all calculations and the number of shares and value of each strategy.
describe what he must do to obtain the same cash flow as he would have gotten from investing in 1000 shares in the proposed levered firm.