Suppose that Lil John Industries’ equity is currently selling for $46 per share

Question

Suppose that Lil John Industries’ equity is currently selling for $46 per share and that 3.9 million shares are outstanding. The firm also has 69,000 bonds outstanding, which are selling at 102 percent of par. Assume Lil John was considering an active change to its capital structure so that the firm would have a (D/E) of 1.5. Which type of security (stocks or bonds) would it need to sell to accomplish this? Sell bonds and buy back stock Sell stock and buy back bonds How much would the firm have to sell? (Enter your answer in dollars not in millions. Do not round intermediate calculations and round your final answer to 2 decimal places.)

Explanation / Answer

Current Equity (E) = 46 x 3.9m = 179.4 million

Current Debt (D) = 69,000 x 102% x 1000 = 70.4 million

In order to increase D/E to 1.5, it need to sell bonds and buy back stock.

Assume it need to sell bonds worth D, then

1.5 = (70.4 + D) / (179.4 - D)

=> D = 79.49 million worth of bonds the firm have to sell.

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