Question

Miller's Dry Goods is an all-equity firm with 50,000 shares of stock outstanding at a market price of $40 a share. The company's earnings before interest and taxes are $142,000. Miller's has decided to add leverage to its financial operations by issuing $500,000 of debt at 6 percent interest and using the proceeds to repurchase shares of stock. You own 500 shares of Miller's stock and can loan out funds at 6 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. 133 shares
B. 100 shares
C. 125 shares
D. 148 shares
D. 150 shares

Answer 1

Answer:

Number of Shares Sold= 125

so correct option is C. 125 shares

Explanation:

given data

stock outstanding = 50,000 shares

market price = $40

interest and taxes = $142,000

debt = $500,000

interest = 6 percent

own = 500 shares

to find out

How many shares of Miller's stock must you sell

solution

we get here shares repurchased that is express as

shares repurchased = $\frac{500000}{40}$

shares repurchased  = $12500

and

no of Shares Outstanding with Debt will be

no of Shares Outstanding with Debt = $50000 - $12500

no of Shares Outstanding with Debt  = $37500

and

Value of Stock will be

Value of Stock = $37500 × $40

Value of Stock = $1500000

and

now Total Value will be

total value  = $500000 + $1500000

total value = $2000000

so Weight of Debt is here

Weight of Debt =  $\frac{500000}{2000000}$

Weight of Debt = 0.25

so Weight of Stock  is

Weight of Stock = $\frac{1500000}{2000000}$

Weight of Stock = 0.75

so

Initial Investment is  = 500 × 40

Initial Investment = $20000

and

Value on New Stock Position will be

Value on New Stock Position = 0.75 × $20000

Value on New Stock Position = $15000

so

New Shares is  =  $\frac{15000}{40}$

New Shares is  = 375

and

Number of Shares Sold will be

Number of Shares Sold = 500 - 375

Number of Shares Sold= 125

so correct option is C. 125 shares