EVALUATING LEVERAGE Gearing Manufacturing, Inc., is planning a $1,000,000 expansion of its production facilities. The expansion could be financed by the sale of $1,250,000 in 8 percent notes or by the sale of $1,250,000 in capital stock, which would raise the number of shares outstanding from 50,000 to 75,000. Gearing pays income taxes at a rate of 30 percent.

Required:

. Suppose that income from operations is expected to be $550,000 per year for the duration of the proposed debt issue. Should Gearing finance with notes or stock?

Explain your answer.

. Suppose that income from operations is expected to be $275,000 per year for the duration of the proposed debt issue. Should Gearing finance with notes or stock?

Explain your answer.

. Suppose that income from operations varies from year to year but is expected to be above $300,000, 40 percent of the time and below $300,000, 60 percent of the time. Should Gearing finance with notes or stock? Explain your answer.

. As an investor, how would you use accounting information to evaluate the risk of excessive use of leverage? What additional information would be useful? Explain.

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