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

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

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Naylor's is an all equity firm with 60,000 shares of stock outstanding at a market price of $50 a share. The company has earnings before interest and taxes of $102,000. Naylor's has decided to issue $750,000 of debt at 7.5 percent. The debt will be used to repurchase shares of the outstanding stock. Currently, you own 500 shares of Naylor's stock. How many shares of Naylor's stock will you continue to own if you unlever this position? Assume you can loan out funds at 7.5 percent interest. Ignore taxes.    A.  322 shares B.  350 shares C.  362 shares D.  425 shares E.  502 shares Naylor's interest = $825,000 × 0.075 = $61,875 Naylor's shares repurchased = $825,000/$50 = 16,500 Naylor's shares outstanding with debt = 60,000 - 16,500 = 43,500 Naylor's EPS, no debt = $102,000/60,000 = $1.70 Naylor's EPS, with debt = ($102,000 - $61,875)/43,500 = $.9224138 Naylor's value of stock = 43,500 × $50 = $2,175,000 Naylor's value of debt = $825,000 Naylor's total value = $2,175,000 + $825,000 = $3,000,000 Naylor's weight stock = $2,175,000/$3,000,000 = 0.725 Naylor's weight debt = $825,000/$3,000,000 = 0.275 Your initial investment = 500 × $50 = $25,000 Your new stock position = 0.725 × $25,000 = $18,125 Your new number of shares = $18,125/$50 = 362.5 shares Check: Your new loans = 0.275 × $25,000 = $6,875 Your unlevered income = 500 × $1.70 = $850 Your levered income = (362.5 × $0.9224138) + ($6,875 × 0.075) = $850