Question

You currently own 800 shares of JKL, Inc. JKL is an all equity that has 700,000 shares of stock outstanding at a market price of $40 a share. The company's earnings before interest and taxes are $5,600,000. You believe that the JKL should finance 50 percent of assets with debt, but management refuses to leverage the company. Given that similar firms' pay 4 percent interest on their debt, answer the following questions.

Part A: How much money should you borrow to create the leverage on your own? Assume you can borrow funds at 4 percent interest.

Part B: How many additional shares of JKL stock must you purchase (using the borrowed funds in Part A) to create the leverage on your own?

Answer 1

I have answered the question below

Please up vote for the same and thanks!!!

Do reach out in the comments for any queries

Answer:

a) Current equity investment = shares * share price = 800 * $40 = $32,000

Interest similar firm’s pay and I can borrow, both are same 4%.

To create 50% leverage on my own, my current equity investment should become 50% of total investment (equity + borrowed funds).

So, my total investment after borrowing funds = 32,000/0.50 = $64,000

Money borrowed = $64,000 - $32000 = $32,000

b) Additional shares of JKL with borrowed funds = 32000/40 = 800 shares