16.15 Mueller Brewing Company has been ordered by the EPA to stop polluting the Menomenie River. It must now spend $100 million on pollution-control equipment. The company has three alternatives for obtaining the needed $100 million.

1. Sell $100 million of perpetual, taxable corporate bonds with a 20-percent coupon rate.

2. Sell $100 million of perpetual pollution-control bonds with a 10-percent coupon rate.

The interest on these bonds is not taxable to investors.

3. Sell $100 million of common stock with a 9.5-percent current dividend yield.

Mueller Brewing Company is in the 35-percent tax bracket.

The president of Mueller Brewing wants to sell the common stock because it has the lowest rate. Mr. Daniels, the company’s treasurer, suggests bond financing because of the tax shield offered by the debt. His analysis shows that the value of the firm would increase rBBTC/rB =
($100 million) * (0.35)
= $35 million if Mueller issues bonds instead of equity. A newly hired financial analyst, Ms. Harris, argues that it does not matter which type of bond is issued. She claims that the yields will be bid up to reflect taxes and, thus, the financing choice will not matter.

a. Comment on the analyses of the president, Mr. Daniels, and Ms. Harris.

b. Should Mueller be indifferent about which financing plan it chooses? If not, rank the three alternatives and give the benefits and costs of each.