You own 400 shares of Kaiser. Kaiser is currently an all equity ﬁrm that has 12,000 shares of stock outstanding at a market price of $50 a share. The company's earnings before interest and taxes are
$20,000. The dividend payout ratio is 100%. Kaiser has decided to issue $100,000 of debt at a 9%
Rate of interest. This $100,000 will be used to repurchase shares of stock. How many shares of
Kaiser stock must you sell to unlever your position if you can loan out funds at a 9% rate of interest?
A) 67 shares
B) 100 shares
C) 133 shares
D) 160 shares
E) 200 shares

Question

Quizplus · Accepted Answer

The correct answer is A.The company's earnings before interest and taxes are $20,000. The dividend payout ratio is 100%. So, the company's dividends are $20,000. The company's market capitalization is $600,000 (12,000 shares * $50 per share). The company's debt-to-equity ratio will be 100,000 / 600,000 = 16.67%. The company's weighted average cost of capital (WACC) will be 9% * 16.67% + 10% * 83.33% = 9.67%. The company's unlevered cost of capital (UACC) will be 10%. So, the company must sell 67 shares of stock to unlever its position.

You Own 400 Shares of Kaiser