Learn and Earn Company Is Financed Entirely by Common Stock

question 64

Multiple Choice

Learn and Earn Company is financed entirely by common stock that is priced to offer a
20% expected rate of return. The stock price is $60 and the earnings per share are $12. The company wishes to repurchase 50% of the stock and substitutes an equal value of debt yielding 8%. Suppose that before refinancing, an investor owned 100 shares of Learn and Earn common stock. What should he do if he wishes to ensure that risk and expected return on his investment are unaffected by refinancing?

• A) Borrow $3,000 and buy 50 more shares
• B) Continue to hold 100 shares
• C) Sell 50 shares and purchase $3,000 debt (bonds)
• D) None of the above

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Definitions:

Gearbox

In a steering mechanism, the use of gears to increase the mechanical advantage and decrease driver effort in turning the steering wheel while converting the wheel’s motion into motion that moves the vehicle’s front wheels.

U-joint

A universal joint, a flexible pivot point that transmits power allowing for varying angles of the drive shaft.

Steering Assembly

The collection of components in a vehicle that allows the driver to guide and direct the vehicle in the desired direction.

Parallelogram Linkage

A linkage in the form of a parallelogram that connects a recirculating ball gearbox to the steering knuckle.