Clover fields is an all equity firm with 55,000 shares of stock outstanding at a market price of $17.50 a share. the company has earnings before interest and taxes of $115,500. clover fields decides to issue $350,000 of debt at an 8% rate of interest

General
1

clover fields is an all equity firm with 55,000 shares of stock outstanding at a market price of $17.50 a share. the company has earnings before interest and taxes of $115,500. clover fields decides to issue $350,000 of debt at an 8% rate of interest. the debt will be used to repurchase shares of the outstanding stock. currently, you own 800 shares of clover fields stock. how many shares of this stock must you sell to unlever your position if you can lend out funds at an 8% rate of interest?

2

How many shares of Clover Fields stock must you sell to unlever your position if you can lend out funds at an 8% rate of interest?

To answer this question, we need to calculate the unlevered position by considering the impact of the debt issued by Clover Fields.

  1. Calculate the total amount of debt issued by Clover Fields:
    Debt issued = $350,000

  2. Calculate the interest expense on the debt:
    Interest expense = Debt issued * Interest rate = $350,000 * 8% = $28,000

  3. Calculate the new earnings before interest and taxes (EBIT):
    New EBIT = Previous EBIT - Interest expense = $115,500 - $28,000 = $87,500

  4. Calculate the new market value of the equity:
    Market value of equity = Stock price * Number of shares = $17.50 * 55,000 = $962,500

  5. Calculate the new market value of the unlevered equity:
    New market value of unlevered equity = Market value of equity + Debt issued = $962,500 + $350,000 = $1,312,500

  6. Calculate the number of shares you need to sell to maintain an unlevered position:
    Unlevered position = New market value of unlevered equity / Stock price = $1,312,500 / $17.50 = 75,000 shares

  7. Calculate the number of shares you need to sell from your current position:
    Shares to be sold = Number of shares currently owned - Shares needed for unlevered position
    Shares to be sold = 800 shares - 75,000 shares = -74,200 shares

Based on the calculations, you need to sell 74,200 shares of Clover Fields stock to achieve an unlevered position. Please note that a negative value indicates that you need to buy additional shares to reach the unlevered position, rather than selling them.