Value Production Corp. currently has a debt to equity ratio of 3.2-to-1, based on $16 million of debt and $5 million of equity. The company is looking to raise $2 million in new financing for an expansion plan. There is a debt covenant that requires the debt to equity ratio to be no higher than 3.5:1, and this is a major factor as the company looks at several financing alternatives.
Alternative 1: Issuance of $2 million of 5% preferred shares, redeemable in cash at the option of the investor.
Alternative 2: Issuance of $2 million of 6% preferred shares, redeemable in cash at the option of Value.
Alternative 3: Issuance of $2 million of 7% secured bonds, convertible into common shares at the option of Value, with conversion based on the market price of common shares at the conversion date.
Alternative 4: Issuance of $2 million of 6.5% unsecured bonds, convertible into common shares at the option of the investor, with conversion at $20 per share. This conversion option is estimated to be worth $250,000.

Required:
1. Calculate and comment on the relative annual cost of each alternative from Value’s perspective. The company has a 35% tax rate. For the investor, what are the attractive elements of each investment?
2. Classify each alternative as debt or equity, and recalculate the debt to equity ratio.
3. Which alternative would you recommend to Value? Explain.