2. Robert Financing has two competing financing alternatives The Company Corp. A. Issue $ 5 million...
2. Robert Financing has two competing financing alternatives The Company Corp.
A. Issue $ 5 million in common stock at $ 50 per share
B. Issuing a straight bond at par value for the same amount as in B with a coupon rate of 10%
C. The Company’s marginal tax rate is 30%
D. The Company currently has 10 million shares of common stock outstanding Required: a. Which of the two financing options is better?
Support your recommendation with numbers b. At what EBIT* level Robert should be indifferent between the two alternatives? (Hint: level of EBIT* is equal of level of equilibrium of the two alternatives)
Homework Answers
a). Issuing a Straight bond at par value of $ 5 million with a 10% coupon rate is a better option
Because,
It will get the company a tax deduction interest from the profit of $ 500,000(5 million * 10%) Every year and there will be no dilution of Power by issuing bonds.
b). At an EBIT of $ 500,000 Robert should be indifferent because at that level the distribution of income to common stock holders & payments to bond holders will be the same & there is a equilibrium of the two alternatives.
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