5 Cornwall Corporation has two alternatives for raising money from financing: 6 7 Plan 1 Plan 2 8 Issue 10% bonds at face value: $2,000,000 9 Issue Common Stock, $10 par $3,000,000 $1,000,000 10 $3,000,000 $3,000,000 Total Financing 11 12 Earnings before interest and income tax $750,000 $750,000 25.00% Rate of Return on Financing 13 Income Tax Rate = 20% 14 Shares Issued 300,000 100,000 shares 15 16 Plan 1 Plan 2 17 EARNINGS BEFORE INTEREST AND TAXES 18 DEDUCT BOND INTEREST 19 INCOME BEFORE INCOME TAX 20 21 INCOME TAX 22 NET INCOME 23 24 SHARES OF COMMON STOCK OUTSTANDING shares 25 EARNINGS PER SHARE 26 27 If the rate of return on Financing > Bond Interest Rate, the borrowing is advantageous. (Favorable Financial Leverage) 28 If the rate of return on Financing