Question

Katz is an all-equity development company that has 36,000 shares of stock outstanding at a market price of $25 a share. The firm's earnings before interest and taxes are $29,000. Katz has decided to issue $200,000 of debt at a rate of 6 percent and use the proceeds to repurchase shares. What should Leslie do if she owns 600 shares of Katz stock and wants to use homemade leverage to offset the leverage being assumed by the firm?

Answer 1

Leslie needs to reduce its investment in the firm by 22.22% and so, needs to sold 133 shares

Step-by-step explanation:

In order to know what should Leslie do we need to calculate first the share repurchased and the value of equity.

Share repurchased = 200,000/ 25 = 8,000

Value of Equity = (36,000- 8,000) * 25 = 700,000

Next, we have to calculate the debt radio, according to data Value of debt = 200,000, hence Debt Ratio = 200,000/ (200,000 + 700,000) = 0.2222

Therefore, Leslie needs to reduce its investment in the firm by 22.22%

So, Leslie will sold stocks = 0.2222 * 600 = 133 shares