1. Beijing Berings is considering purchasing a small firm in the same line of business. The purchase would be financed by the sale of common stock or a bond issue. The financial manager needs to evaluate how the two alternative financing plans will affect the earnings potential of the firm. Total financing required is 4.5 million. The firm currently has 20,000,000 of 12% bonds and 600,000 common shares outstanding. The firm can arrange financing of the 4.5 million through a 14% bond issue of the sale of 100,000 shares of common stock. The firm has a 40% tax rate and has EBIT of 7,000,000.

a. What is the degree of financial leverage if the company were to issue new bonds?

b. What is the degree of financial leverage if the company were to sell shares of common stock?