Question

Shoe Box Stores is currently an all-equity firm with 25,000 shares of stock outstanding. Management is considering changing the capital structure to 35 percent debt. The interest rate on the debt would be 8 percent. Ignore taxes. Jamie owns 600 shares of Shoe Box Stores stock that is priced at $22 a share. What should Jamie do if she prefers the all-equity structure but Shoe Box Stores adopts the new capital structure?

Answer 1

Answer: d. Sell 210 shares and loan out the proceeds at 8 percent

Explanation:

Because the Firm wants to use a Debt to Equity Capital structure instead of an All Equity structure, she can lend money out at the company interest rate to NEGATE the conversion.

She can do this by selling 35% of her portfolio and loaning it out at 8%

35 % of her Portfolio would be,

= 0.35 * 600

= 210 shares

So she can sell 210 shares and loan at the proceeds at 8% to offset the Company's conversion