Martin and Sons (M and S) currently is an all equity firm with 50,000 shares out

Question

Martin and Sons (M and S) currently is an all equity firm with 50,000 shares outstanding at a market price of $20 a share. The company's earnings before interest and taxes are $80,000. M and S has decided to add leverage to their financial operations by issuing $600,000 of debt with a 7 percent interest rate. This $600,000 will be used to repurchase shares. You own 900 M and S shares. You also loan out funds at a 7 percent rate of interest. How many of your shares in M and S must you sell to offset the leverage that the firm is assuming? Assume that you loan out all of the funds you receive from the sale of your shares.

Explanation / Answer

Martin and Sons (M and S) currently is an all equity firm with 50,000 shares outstanding at a market price of $20 a share. The company's earnings before interest and taxes are $80,000. M and S has decided to add leverage to their financial operations by issuing $600,000 of debt with a 7 percent interest rate. This $600,000 will be used to repurchase shares. You own 900 M and S shares. You also loan out funds at a 7 percent rate of interest. How many of your shares in M and S must you sell to offset the leverage that the firm is assuming? 1,008 shares

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