Question

Tom Scott is the owner, president, and primary salesperson for Scott Manufacturing. Because of this, the company's profits are driven by the amount of work Tom does. If he works 40 hours each week, the company's EBIT will be $630,000 per year; if he works a 50-hour week, the company's EBIT will be $785,000 per year. The company is currently worth $4.00 million. The company needs a cash infusion of $2.10 million, and it can issue equity or issue debt with an interest rate of 10 percent. Assume there are no corporate taxes.

a. What are the cash flows to Tom under each scenario? (Enter your answers in dollars, not millions of dollars, e.g. 1,234,567. Do not round intermediate calculations.)

Scenario-1
Debt issue:
Cash flows
40-hour week $
50-hour week $

Scenario-2
Equity issue:
Cash flows
40-hour week $
50-hour week $

Answer 1

The cash flows for Scott Manufacturing at a 50-hour work week by Tom Scott and opting for debt financing would result in net earnings of $575,000, which is the EBIT of $785,000 minus the annual interest of $210,000 from the cash infusion.

Step-by-step explanation:

The question focuses on determining the cash flows of Scott Manufacturing if Tom Scott, the owner and president, works a 50-hour week. To calculate cash flows under this scenario, we must consider the EBIT (earnings before interest and taxes) the company would generate with the increased working hours and any costs associated with financing options. Given that the EBIT is $785,000 when Tom works 50 hours per week, we can use this information to infer the company's financials.

If Scott Manufacturing opts for equity financing, the EBIT would likely remain untouched, assuming no dilution of control affecting operations negatively. However, if the company chooses to issue debt with an interest rate of 10 percent on the $2.10 million cash infusion, the annual interest expense would be $210,000 (10% of $2.10 million), which would have to be subtracted from the EBIT to obtain the net earnings. With no corporate taxes, the net earnings would be represented by the EBIT minus the interest expense for the debt option.

Therefore, the cash flow for the company if it issues debt would be $785,000 - $210,000, equating to $575,000. This simplified analysis does not account for any other operational or financing-related costs but provides a basic framework for understanding the impact of Tom Scott's increased work hours on the company's cash flows.