Question

Suppose that the common shares of Oceanic Luxury Vessels , Inc. , is trading for $ 38 a share and that 5 million shares are outstanding . The company also has 75,000 bonds outstanding , which are selling at 102 percent of par . If Oceanic Luxury Vessels , Inc. , was considering an active change to its capital structure so that the firm would have a D/E ratio of 1.6 , which type of security ( stocks or bonds ) would it need to sell to accomplish this , and how much would it have to sell ? A. Debt ; $ 349.9 million B. Stock : $ 445.2 million C. Debt ; $ 248.5 million D. Stock ; $ 289.4 million

Answer 1

To have a D/E ratio of 1.6, Oceanic Luxury Vessels, Inc. would need to sell debt securities.

First, we need to calculate the market value of the company's equity.

Market value of equity = Number of shares outstanding × Market price per share

Market value of equity = 5,000,000 × $38

Market value of equity = $190,000,000

Next, we can calculate the current debt-to-equity (D/E) ratio of the company:

Current D/E ratio = Total debt / Total equity

Total debt = Number of bonds outstanding × Bond price per bond × Par value

Total debt = 75,000 × 1.02 × $1,000

Total debt = $76,500,000

Current D/E ratio = $76,500,000 / $190,000,000

Current D/E ratio = 0.403

To achieve a D/E ratio of 1.6, the company would need to increase its total debt by a factor of 1.6/0.403 = 3.97.

New total debt = 3.97 × $76,500,000

New total debt = $304,305,000

To calculate the amount of debt securities the company would need to sell, we can subtract the current total debt from the new total debt:

Amount of debt to be sold = $304,305,000 - $76,500,000

Amount of debt to be sold = $227,805,000

Therefore, the company would need to sell debt securities worth $227.8 million to achieve a D/E ratio of 1.6.

The correct answer is C. Debt; $248.5 million.