Katz is an all-equity development company that has 36,000 shares of stock outstanding at a market price of $25 a share. The firm's earnings before interest and taxes are $29,000. Katz has decided to issue $200,000 of debt at a rate of 6 percent and use the proceeds to repurchase shares. What should Faith do if she owns 500 shares of Katz stock and wants to use homemade leverage to offset the leverage being assumed by the firm?
A) Borrow money and buy an additional 22 shares
B) Borrow money and buy an additional 111 shares
C) Sell 22 shares and loan out the proceeds
D) Sell 56 shares and loan out the proceeds
E) Sell 111 shares and loan out the proceeds

Question

Quizplus · Accepted Answer

Faith should sell 111 shares and loan out the proceeds to offset the leverage being assumed by the firm. This is because the firm is increasing its debt, and to maintain her original equity position, she needs to reduce her equity holding proportionally.

Katz Is an All-Equity Development Company That Has 36,000 Shares