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 $615,000 per year; if he works a 50 hour week, the company's EBIT will be $755,000 per year. The company is currently worth $3.85 million. The company needs a cash infusion of $1.95 million, and it can issue equity or issue debt with an interest rate of 7 percent. Assume there are no corporate taxes.

What are the cash flows to Tom under each scenario?

Answer 1

Please see answer as attached.

Step-by-step explanation:

a. What are the cash flows to Tom under each scenario.

•Cash flow under scenario 1.

40 hour week cash flow $478,500

50 hour week Cash flow $618,500

Total ownership percentage 66.38%

•Scenario 2.

40 week cash flow $408,237

50 week cash flow $501,169

Please find attached detailed computation of the above solution.