Question

You currently own 900 shares of JKL which is an all-equity firm with 250,000 shares of stock outstanding at a market price of $40 a share. The company's earnings before interest and taxes are $120,000. JKL has decided to issue $1 million of debt at 6.5 percent interest and use the proceeds to repurchase shares of stock. How many shares of JKL stock must you sell to unlever your position if you can loan out funds at 6.5 percent interest

Answer 1

90 shares

Step-by-step explanation:

Calculation to determine How many shares of JKL stock must you sell to unlever your position if you can loan out funds at 6.5 percent interest

First step is to calculate Your initial investment

Your initial investment = 900 x $40

Your initial investment = $36,000

Second step is to calculate JKL value of stock

JKL value of stock = [250,000 - ($1M/$40)] x $40 JKL value of stock = $9M

Third step is to calculate JKL Total value

Value of Debt = 1M

JKL Total value = 9M + 1M

JKL Total value = 10M

Fourth Step is to calculate You new stock position

JKL Wight Stock = 9M/10M = 9/10

You new stock position = [9/10($36,000)]/10

You new stock position= $32,400/40

You new stock position=810 shares

Now let calculate the Number shares sold

Number shares sold = 900 Shares - 810 Shares

Number shares sold = 90 shares

Therefore the numbers or shares of JKL stock that must you sell to unlever your position if you can loan out funds at 6.5 percent interest is 90 shares