A company's capital structure is made up of 200,000 common shares and $1,000,000 debt at 12 percent interest. The company's tax rate is 40 percent. An additional $500,000 has to be raised, and the following financing alternatives are available:

* Common shares: The company can sell additional shares to net $10 a share.

*Debt: Debt can be issued at 14%.

Management has advised that they expect EBIT to average $350,000 for the next five years.

Required:

a) Calculate the break-even EBIT for the two financing options.

b) Which financing option would you recommend and why