Jungle Cat Petting Zoo Inc. is currently all equity financed. It used to be leveraged, but it recently issued 5,000 new shares at $50 per share. The proceeds from the new issue were used to repay all of its debt. Financial details for the current and old capital structures are presented in the table below. Assume that Jungle Cat generates perpetual annual EBIT at a constant level. Assume that all cash flows occur at the end of the year and we are currently at the beginning of a year. Assume that taxes are zero. Assume that all of net income is paid out as a dividend. Assume that the debt is perpetual with annual coupons at 3%. Assume that individual investors can borrow and lend at the same interest rate (and with the same terms)as corporations.
Leo Delgato is a shareholder in Jungle Cat who owns 6,750 shares. After the new issue, Leo is unhappy with his dividends. How many shares does Leo have to buy (or sell)in order to return his annual cash flows to the level he enjoyed when the company was leveraged?
$$\begin{array} { | c | c | c | }
\hline & \begin{array} { c }
\text { Capital } \
\text { Structure }
\end{array} & \begin{array} { c }
\text { Capital } \
\text { Structure }
\end{array} \
\hline & \text { Old (Levered) } & \begin{array} { c }
\text { Current (All- } \
\text { Equity) }
\end{array} \
\hline \text { EBIT } & \$ 125,000 & \$ 125,000 \
\hline \text { Debt, D } & \$ 250,000 & \$ 0 \
\hline \begin{array} { c }
\text { Cost of Debt, } \
\mathrm { k } _ { \mathrm { d } }
\end{array} & 3 \% & \text { N/A } \
\hline \begin{array} { c }
\text { Shares } \
\text { Outstanding }
\end{array} & 45,000 & 50,000 \
\hline \text { Stock Price } & \$ 50.00 & \$ 50.00 \
\hline \begin{array} { c }
\text { Dividends per } \
\text { share }
\end{array} & \$ 2.611 & \$ 2.50 \
\hline
\end{array}$$

Question

Jungle Cat Petting Zoo Inc. is currently all equity financed. It used to be leveraged, but it recently issued 5,000 new shares at $50 per share. The proceeds from the new issue were used to repay all of its debt. Financial details for the current and old capital structures are presented in the table below. Assume that Jungle Cat generates perpetual annual EBIT at a constant level. Assume that all cash flows occur at the end of the year and we are currently at the beginning of a year. Assume that taxes are zero. Assume that all of net income is paid out as a dividend. Assume that the debt is perpetual with annual coupons at 3%. Assume that individual investors can borrow and lend at the same interest rate (and with the same terms)as corporations.
Leo Delgato is a shareholder in Jungle Cat who owns 6,750 shares. After the new issue, Leo is unhappy with his dividends. How many shares does Leo have to buy (or sell)in order to return his annual cash flows to the level he enjoyed when the company was leveraged?
$$\begin{array} { | c | c | c | } 
\hline & \begin{array} { c } 
\text { Capital } \
\text { Structure }
\end{array} & \begin{array} { c } 
\text { Capital } \
\text { Structure }
\end{array} \
\hline & \text { Old (Levered) } & \begin{array} { c } 
\text { Current (All- } \
\text { Equity) }
\end{array} \
\hline \text { EBIT } & \$ 125,000 & \$ 125,000 \
\hline \text { Debt, D } & \$ 250,000 & \$ 0 \
\hline \begin{array} { c } 
\text { Cost of Debt, } \
\mathrm { k } _ { \mathrm { d } }
\end{array} & 3 \% & \text { N/A } \
\hline \begin{array} { c } 
\text { Shares } \
\text { Outstanding }
\end{array} & 45,000 & 50,000 \
\hline \text { Stock Price } & \$ 50.00 & \$ 50.00 \
\hline \begin{array} { c } 
\text { Dividends per } \
\text { share }
\end{array} & \$ 2.611 & \$ 2.50 \
\hline
\end{array}$$

Quizplus · Accepted Answer

Leo needs to buy 750 shares to maintain his previous dividend income. Under the old structure, his dividend income was 6,750 shares * $2.611 = $17,625.75. Under the new structure, his dividend income is 6,750 shares * $2.50 = $16,875. To make up the difference, he needs an additional $750.75 in dividends, which requires buying 750 shares (750 * $2.50 = $1,875).

Jungle Cat Petting Zoo Inc A)Buy 750 Shares B)Sell 750 Shares C)Buy 675 Shares D)Sell

Jungle Cat Petting Zoo Inc A)Buy 750 Shares
B)Sell 750 Shares
C)Buy 675 Shares
D)Sell