Contemporary Business 14th Edition by Louis Boone, David Kurtz

Exercise 1

Working with a partner, assume that a firm needs $10 million in additional long-term capital. It currently has no debt and $40 million in equity. The options are issuing a ten-year bond (with an interest rate of 7 percent) or selling $10 million in new equity. You expect next year's earnings before interest and taxes to be $5 million. (The firm's tax rate is 35 percent.) Prepare a memo outlining the advantages and dis-advantages of debt and equity financing. Using the numbers provided, prepare a numerical illustration of leverage similar to the one shown in Figure 17.2.