Laffoley Corp. needs to raise $10,000,000 to finance a planned capital expansion. The company has investigated two alternatives:
1. Issue $10 million of preferred shares at par. The shares can be redeemed at the company’s option at the end of 12 years for a price estimated to be in the region of $11,000,000. Annual (cumulative) dividends would amount to $585,000.
2. Issue bonds, which the company can buy back on the open market at the end of 12 years; analysts estimate that it would cost $11,000,000 to reacquire the $10,000,000 issue. 

Annual interest would amount to $900,000.

Required:
1. Assume Laffoley’s tax rate is 35%. What is the after-tax annual cost of the two alternatives?
2. Provide journal entries to record issuance, annual dividends, or interest (for one year only), and retirement of both the shares and debt.
3. Assume that earnings, before interest and tax, in year 12 was $3,000,000. The tax rate was 35%. Calculate earnings if equity were outstanding in year 12, and retired at the end of the year. Calculate earnings if debt were outstanding in year 12 and retired at the end of the year.