ABC Co. is an all-equity firm, valued at $900 million. It has 9 million shares outstanding. It generates an annual cash flow of $72 million. ABC wants to change its capital structure to 33.3% debt and 66.7% equity (i.e., D/E ratio being 0.5) by borrowing $300 million and repurchase 3 million shares. It can borrow at 7.5% interest rate. The firm faces 0 tax rate (tax exempt).

If ABC does not lever up, but a shareholder owning 12 shares wants to replicate the returns from a levered firm, what should he do?

• Borrow $400 at the rate of 7.5% and buy 4 more shares

• None of the other choices is correct

• Sell 4 shares and deposit $400 at the rate of 7.5%

• Sell 6 shares and deposit $600 at the rate of 7.5%

• Borrow $600 at the rate of 7.5% and buy 6 more shares