UNLEV has an expected perpetual EBIT = $4,000. The unlevered cost of capital = 15% and there are 20,000 shares of stock outstanding. The firm is considering issuing $8,800 in new par bonds to add financial leverage to the firm. The proceeds of the debt issue will be used to repurchase equity. The cost of debt = 10% and the tax rate = 34%. There are no flotation costs.

Assume a stockholder owns 1,000 shares of UNLEV before the restructuring. The stockholder prefers a debt/equity ratio = 1.0. How could the stockholder use homemade leverage to achieve the restructuring without the help of UNLEV? Assume there are no taxes.
A) The stockholder should borrow $1,330 and buy 1,000 more shares of UNLEV.
B) The stockholder should borrow $2,660 and buy 1,000 more shares of UNLEV.
C) The stockholder should borrow $1,330 and buy 2,000 more shares of UNLEV.
D) The stockholder should lend $667 and sell 300 shares of UNLEV.
E) The stockholder should lend $1,337 and sell 667 shares of UNLEV.

Question

UNLEV has an expected perpetual EBIT = $4,000. The unlevered cost of capital = 15% and there are 20,000 shares of stock outstanding. The firm is considering issuing $8,800 in new par bonds to add financial leverage to the firm. The proceeds of the debt issue will be used to repurchase equity. The cost of debt = 10% and the tax rate = 34%. There are no flotation costs.

Assume a stockholder owns 1,000 shares of UNLEV before the restructuring. The stockholder prefers a debt/equity ratio = 1.0. How could the stockholder use homemade leverage to achieve the restructuring without the help of UNLEV? Assume there are no taxes.
A) The stockholder should borrow $1,330 and buy 1,000 more shares of UNLEV.
B) The stockholder should borrow $2,660 and buy 1,000 more shares of UNLEV.
C) The stockholder should borrow $1,330 and buy 2,000 more shares of UNLEV.
D) The stockholder should lend $667 and sell 300 shares of UNLEV.
E) The stockholder should lend $1,337 and sell 667 shares of UNLEV.

Quizplus · Accepted Answer

The stockholder should borrow $1,330 and buy 1,000 more shares of UNLEV.The stockholder wants to achieve a debt/equity ratio of 1.0. The firm currently has $0 of debt and 20,000 shares of equity, so the stockholder needs to increase the debt/equity ratio by 1.0. The stockholder can do this by borrowing $1,330 and buying 1,000 more shares of UNLEV. This will increase the debt/equity ratio to 1.0 and will also increase the stockholder's ownership stake in the firm.

UNLEV Has an Expected Perpetual EBIT = $4,000