UNLEV Has an Expected Perpetual EBIT = $4,000

question 357

Multiple Choice

UNLEV has an expected perpetual EBIT = $4,000. The unlevered cost of capital = 15% and there are 20,000 shares of stock outstanding. The firm is considering issuing $8,800 in new par bonds to add financial leverage to the firm. The proceeds of the debt issue will be used to repurchase equity. The cost of debt = 10% and the tax rate = 34%. There are no flotation costs.

Assume a stockholder owns 1,000 shares of UNLEV before the restructuring. Also assume UNLEV's debt/equity ratio will be 0.493 after the restructuring. How could the stockholder use homemade leverage to unlever her investment in the firm after the restructuring? Assume there are no taxes.

• A) The stockholder should borrow $1,330 and buy 1,000 more shares of UNLEV.
• B) The stockholder should borrow $2,660 and buy 1,000 more shares of UNLEV.
• C) The stockholder should borrow $1,330 and buy 2,000 more shares of UNLEV.
• D) The stockholder should lend $443 and sell 333 shares of UNLEV.
• E) The stockholder should lend $1,337 and sell 667 shares of UNLEV.

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Definitions:

Excise Taxes

Taxes levied on specific goods or services, such as alcohol and tobacco, often intended to discourage their use or raise revenue.

Progressive

A social or political ideology that advocates for reform and innovation, emphasizing progressive changes in society.

Direct Taxes

Taxes levied directly on an individual's or organization's income or wealth.

Marginal Tax Rate

The percentage of tax levied on each additional dollar of income, representing the tax rate applicable to every tax bracket for which you're eligible.