Miller's Dry Goods is an all equity firm with 48,000 shares of stock outstanding at a market price of $50 a share

Miller's Dry Goods is an all equity firm with 48,000 shares of stock outstanding at a market price of $50 a share. The company's earnings before interest and taxes are $128,000. Miller's has decided to add leverage to its financial operations by issuing $250,000 of debt at 8 percent interest. The debt will be used to repurchase shares of stock. You own 400 shares of Miller's stock. You also loan out funds at 8 percent interest. How many shares of Miller's stock must you sell to offset the leverage that Miller's is assuming? Assume you loan out all of the funds you receive from the sale of stock. Ignore taxes.    A.  35.6 shares B.  40.0 shares C.  41.67 shares D.  47.5 shares E.  50.1 shares Miller's interest = $250,000 × 0.08 = $20,000 Miller's shares repurchased = $250,000/$50 = 5,000 Miller's shares outstanding with debt = 48,000 - 5,000 = 43,000 Miller's EPS, no debt = $128,000/48,000 = $2.666667 Miller's EPS, with debt = ($128,000 - $20,000)/43,000 = $2.511628 Miller's value of stock = 43,000 × $50 = $2,150,000 Miller's value of debt = $250,000 Miller's total value = $2,150,000 + $250,000 = $2,400,000 Miller's weight stock = $2,150,000/$2,400,000 = 0.895833 Miller's weight debt = $250,000/$2,400,000 = 0.104167 Your initial investment = 400 × $50 = $20,000 Your new stock position = 0.895833 × $20,000 = $17,916.67 Your new number of shares = $17,916.67/$50 = 358.3333 Number of shares sold = 400 - 358.3333 = 41.67 shares Check: Your new loans = 0.104167 × $20,000 = $2,083.33 Your total unlevered income = 400 × $2.666667 = $1,066.67 Your total levered income = (358.3333 × $2.511628) + ($2,083.33 × 0.08) = $11,066.67

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You currently own 600 shares of JKL, Inc. JKL is an all equity firm that has 75,000 shares of stock outstanding at a market price of $40 a share. The company's earnings before interest and taxes are $140,000. JKL has decided to issue $1 million of debt at 8 percent interest. This debt will be used to repurchase shares of stock. How many shares of JKL stock must you sell to unlever your position if you can loan out funds at 8 percent interest?    A.  120 shares B.  150 shares C.  180 shares D.  200 shares E.  250 shares JKL interest = $1m × 0.08 = $80,000 JKL shares repurchased = $1m/$40 = 25,000 JKL shares outstanding with debt = 75,000 - 25,000 = 50,000 JKL EPS, no debt = $140,000/75,000 = $1.866667 JKL EPS, with debt = ($140,000 - $80,000)/50,000 = $1.20 JKL value of stock = 50,000 × $40 = $2m JKL value of debt = $1m JKL total value = $2m + $1m = $3m JKL weight stock = $2m/$3m = 2/3 JKL weight debt = $1m/$3m = 1/3 Your initial investment = 600 × $40 = $24,000 Your new stock position = 2/3($24,000) = $16,000 Your new number of shares = $16,000/$40 = 400 Number of shares sold = 600 - 400 = 200 shares Check: Your new loans = 1/3($24,000) = $8,000 Your unlevered income = 600 × $1.866667 = $1,120 Your levered income = (400 × $1.20) + ($8,000 × 0.08) = $1,120