Parker & Thomas, Inc., (P&T) currently is an all equity firm with 20,000 shares of stock outstanding at a market price of $40 a share. The company’s earnings before interest and taxes are $50,000.
The firm’s dividend payout ratio is 100%. P&T has decided to add leverage to its financial operations by issuing $400,000 of debt at a 9% interest rate. This $400,000 will be used to repurchase shares of stock.
You own 2,500 shares of P&T stock. You lend funds at a 9% rate of interest. How many of your shares of stock in P&T must you sell to offset the leverage that the firm is assuming? Assume that you loan out all of the funds you receive from the sale of your stock.
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