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 disadvantages of debt and equity financing. Using the numbers provided, prepare a numerical illustration of leverage similar to the one shown in Figure 17.2.