Question

Theo currently owns 700 shares of JKL, which is an all-equity firm with 320,000 shares of stock outstanding at a market price of $25 a share. The company's earnings before interest and taxes are $160,000. JKL has decided to issue $500,000 of debt at 7.5 percent interest and use the proceeds to repurchase shares of stock. How many shares of JKL stock must Theo sell to unlever his position if he can loan out funds at 7.5 percent interest? (Assume partial shares can be sold.)
a. 38.50
b. 50.00
c. 43.75
d. 42.50
e. 46.67

Answer 1

Answer:

correct option is c. 43.75

Explanation:

given data

share own = 700

stock outstanding = 320000

market price = $25

interest and taxes =  $160,000

debt = $500,000

interest = 7%

loan = 7.5 percent interest

to find out

How many shares of JKL stock must Theo sell to unlever

solution

first we get here no of share that repurchased is express  as

no of share =  $\frac{debt}{market\ price}$     ..............1

no of share =  $\frac{500000}{25}$

no of share = 20,000 shares

sell = share own × ( no of share ÷ stock outstanding  )    .................2

sell = 700 × $\frac{20000}{320000}$

sell = 43.75 shares

so correct option is c. 43.75