23. value: 1.00 points MC Qu. 16-A2 Martin and Sons (M and S) currently is an al

Question

23. value: 1.00 points MC Qu. 16-A2 Martin and Sons (M and S) currently is an all equity fi... Martin and Sons (M and S) currently is an all equity firm with 76,000 shares of stock outstanding at a market price of $30 a share. The company's earnings before interest and taxes are $89,000. M and S has decided to add leverage to their financial operations by issuing $570,000 of debt with a 10% percent interest rate. This 570,000 will be used to repurchase shares of stock. You own 3,000 shares of M and S stock. You also loan out funds at a 10% 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 220 shares O 795 shares 675 shares 825 shares 750 shares

Explanation / Answer

To unleverage or to offset the leverage of firm's borrowing, you need sell shares in the same percentage as the borrowing in the new capital structure. The market value before issue of debt and post issue will be equal.

Total Market value of firm (before debt) = 76000 x 30 = $2,280,000

Equity value (post debt) = $2,280,000 - $570,000 = $1,710,000

Debt ratio in the new capital structure = $570000/ $2280000 = 25%

No. of shares to be sold = 3000 shares x 25% = 750 shares

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