Martin and Sons (M and S) currently is an all equity firm with 48,000 shares of

Question

Martin and Sons (M and S) currently is an all equity firm with 48,000 shares of stock outstanding at a market price of $25 a share. The company's earnings before interest and taxes are $82,000. M and S has decided to add leverage to their financial operations by issuing $360,000 of debt with a 7% percent interest rate. This $360,000 will be used to repurchase shares of stock. You own 2,300 shares of M and S stock. You also loan out funds at a 7% percent rate of interest. How many of your shares of stock 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 stock.

Explanation / Answer

Total Shares Purchased using raised amount = $360,000/$25 = 14,400 Shares
Percentage Decrease in Shares = 14,400/48,000 = 0.3 or 30% (This proportion will be replaced by debt)

So, You also need to sell 30% of your shares.
Number of shares to be sold to attain same level of leverage = 2,300 x 30% = 690 Shares

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