Question

KMS corporation has assets of $400 million, $40 million of which are cash. It has debt of $100 million. If KMS repurchases $13.3 million of its stock: a. What changes will occur on its balance sheet? b. What will be its new leverage ratio? a. What changes will occur on its balance sheet? (Select the best choice below.) O A. Both the cash balance and shareholder equity will increase by $13.3 million OB. Both accounts receivable and shareholder equity will drop by $13.3 million. OC. Both the cash balance and shareholder equity will drop by $13.3 million. OD. Debt will increase by $13,3 million and shareholder equity will decrease by $13.3 million b. What will be its new leverage ratio? The new leverage ratio after the repurchase is % (Round to one decimal place.)

Answer 1

a. The Correct Answer is C. Both Cash Balance and Shareholder equity will drop by $13.3 million.

In Repurchase of Shares of Buyback, a company repurchases its shares from the shareholders and pay cash as its consideration to the shareholders. Buyback or Repurchase of Shares is usally done to keep a check on the falling stock prices and also to get more control of the company.

When repurchase of shares occur then the outstanding number of shares decreases as the company is buying it back from the stockholders and its cash balances also reduce as the shareholders are paid in cash for their shares.

Therefore Both the cash balance and shareholder equity will drop as a result of Repurchase of Shares.

b. The Answer is 25.9 %

Leverage Ratio = Total Debt / Total Asset

Total Debt = $100 million

Total Asset = ($400 million - $13.3 million)

= $386.7 million

Note - Cash balance which is part of Asset will reduce by $13.3 million due to Repurchase of Shares

Therefore Leverage Ratio

= $100 million / $386.7 million

= 0.2586 or we can say 25.86%

Now rounding off to once decimal place

= 25.9%