Debt and Equity Financing
Berlin Company is in a world of hurt. For the past 15 years, the company has been the exclusive
toy supplier to Infants-R-Us toy stores. Unfortunately for Berlin Company, Infants-R-Us
just declared bankruptcy and went out of business. Berlin is the supplier for a few local toy
stores, but Infants-R-Us was by far its largest customer. Berlin’s managers believe that they
can save the company if they can raise enough money to develop a new product line of a
popular toy, “Nano Babies.” Developing the new product line will require a considerable investment,
however. Berlin is trying to decide the best way to finance the investment. It has
found a bank that will loan it the money at 18%, a very high rate but the only one it can get
because of its precarious financial position. Berlin can also issue bonds to raise the money,
but because of investors’ concerns about the future viability of the company, the only kind
of bonds investors will buy are high-interest junk bonds at an interest rate of 17%. Even
then, there is concern that the bonds will be discounted when they are marketed. Which financing
alternative would you recommend to the company? If you were an investor, would
you buy Berlin Company’s bonds?