Austin-Healey Motors Inc. is currently levered. It used to be all-equity, but it recently borrowed and used the money to repurchase 50,000 shares. Financial details for the current and old capital structures are presented in the table below.
Assume that Austin-Healey generates perpetual annual EBIT at a constant level. Assume that all cash flows occur at the end of the year and we are currently at the beginning of a year. Assume that taxes are zero. Assume that all of net income is paid out as a dividend. Assume that the debt is perpetual with annual coupons at 3%. Assume that individual investors can borrow and lend at the same interest rate (and with the same terms) as corporations.
Nigel Mansell is a shareholder in Austin-Healey who owns 5,000 shares. After the repurchase, Nigel is unhappy with his dividends. How many shares does Nigel have to buy (sell) in order to return his annual cash flows to what they were under the all-equity capital structure? (Assume that Nigel had the same number of shares under the old structure.)
| | Capital Structure | Capital Structure |
| | Old (All-Equity) | Current (Levered) |
| EBIT | $150,000 | $150,000 |
| Debt, D | $0 | $1,500,000 |
| Cost of Debt, kd | N/A | 3% |
| Shares Outstanding | 100,000 | 50,000 |
| Stock Price | $30.00 | $30.00 |
| Dividends per share | $1.50 | $2.10 |
◦ Sell 3,572 shares
◦ Sell 2,500 shares
◦ Sell 2,143 shares
◦ Buy 3,572 shares
◦ Buy 2,764 shares
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