Twin City publishing is considering two financial alternatives for financing a major expansion program. Under either alternative EBIT is expected to be $15.6 million.
Currently the firm's capital structure consists of $ 4 million shares of common stock and $35 million in 11% long-term bonds.
Under the debt financing alternative $ 10 million in 12% long-term bonds will be sold and under the equity financing alternative the firm would sell 500,000 shares of common stock.
The P/E (Price -Earning Ration) under the debt alternative would be 15 and the P/E under the equity alternative would be 16. The firm's tax rate is 40%.
Which alternative would the firm choose? Show your workings and explain your findings.
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