Jetpack Ltd. has an all equity capital structure. It has total assets worth $10 million, 10,000 outstanding shares and an EBIT of $750,000. It is contemplating a move to incorporate debt to the tune of 25% of its asset value and can arrange the borrowing at a 5% p.a. interest rate. Wendy, a shareholder in the company, has 700 shares. i) What is Wendy's current percentage return if Jetpack follows a 100% dividend pay-out policy and there are no taxes? ii) If Wendy prefers the company to remain all equity financed, show how she could unlever her position to maintain the same percentage return as she is earning currently?

Jetpack Ltd. has an all equity capital structure. It has total assets worth $10 million, 10,000 outstanding shares and an EBIT of $750,000. It is contemplating a move to incorporate debt to the tune of 25% of its asset value and can arrange the borrowing at a 5% p.a. interest rate. Wendy, a shareholder in the company, has 700 shares. i) What is Wendy's current percentage return if Jetpack follows a 100% dividend pay-out policy and there are no taxes? ii) If Wendy prefers the company to remain all equity financed, show how she could unlever her position to maintain the same percentage return as she is earning currently?

EBK CFIN

6th Edition

ISBN:9781337671743

Author:BESLEY

Publisher:BESLEY

Chapter11: The Cost Of Capital

Section: Chapter Questions

Problem 15PROB

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Question

Jetpack Ltd. has an all equity capital structure. It has total assets worth $10 million, 10,000 outstanding shares and an EBIT of $750,000. It is contemplating a move to incorporate debt to the tune of 25% of its asset value and can arrange the borrowing at a 5% p.a. interest rate. Wendy, a shareholder in the company, has 700 shares.
1. i) What is Wendy's current percentage return if Jetpack follows a 100% dividend pay-out policy and there are no taxes?
2. ii) If Wendy prefers the company to remain all equity financed, show how she could unlever her position to maintain the same percentage return as she is earning currently?

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