A firm that wants to raise $21 million has 500,000 common shares outstanding, with a current

market value of $1

5

per share. The firm's

tax rate is 4

0

percent

.

(a)

The alternatives are to issue common shares or to

issue

20

-

year debentures

(bond

s)

at

face value with annual interest payments of 12 percent. Issuing and underwrit

ing

costs

can be

ignored.

Compute the indifference

EBIT

between common shares and bonds

.

If expected EBIT is greater than the indi

fference EBIT

which financing option should be pursued?