MINICASE In March 2023, the management team of Londonderry Air (LA) met to discuss a proposal to purchase five shorthaul aircraft at a total cost of 525 million. There was general enthusiasm for the inwestment, and the new aircraft were expected to generate an annual cash flow of $4 million for 20 years. The focus of the meeting was on how to fnance the purchase. LA had $20 million in cash and marketable securities (see table), but Ed Johnson, the chief financial offoer, pointed out that the company needed at least $10 million in cash to meet normal outilow and as a contingency reserve. This meant that there would be a cash deflciency of $15 million, which the firm would need to corer either by the sale of common stock or by additional borrowing. While admitting that the argumeats were finely balanced, Mr. Johnson recommended an issue of stock. He pointed out that the airline industry was subject to wide swings in profts and the firm should be careful to avoid the risk of excessive borrowing. He estimated that in markst value terms, the long-term debt ratio was about 59% and that a further debt issue would raise the ratio to 62%. Mr. Johnson's only doubt about making a stock issue was that investors might jump to the conclusion that management believed the stock was overpriced, in which case the announcement might prompt an unjustifled sellofi by investors. He stressed, therefore, that the company needed to explain carefully the reasons for the issue. Also, he suggested that demand for the issue would be enhanced if at the same time LA increased its dividend payment. This would proride a tangible indication of management's confldence in the future. Summary financial statements for Londonderry Air, 2022 (Figures are book values, in millions of dollars) "The youd to mahirity on LA dabt cunsorlily is 6% These arguments cut little ice with L.A's chief executive. "Ed," she said, "I know that you're the expert on all this, but everything you say flies in the face of common sense. Why should we want to sell more equity when our stock has fallen orer the past year by nearly a fifth? Our stocik is currently offering a dividend yield of 6.5%, which makes equity an expensive source of capital. Increasing the dividend would simply make it more expensive. What's more, I don't see the point of paying out more money to the stockholders at the same time that we are asking tham for cash. If we hike the dividend, we will need to increase the amount of the stock issue; so we will just be paying the higher dividend out of the shareholders" own pocksts. You're also ignoring the question of dihtion. Our equity currently has a book value of $12 a share; it's not playing fair 'by our existing shareholders if we now issue stocis for around 810 a share. "Look at the alternative. We can borrow today at 6%. We get a tax break on the interest, so with a 21% tax rate, the after-tax cost of borrowing is (1.21)6%=4.74%. That's less than the cost of equity. We expect to earn a return of 15% on these new aircraft. If we can raise money at 4.74% and invest it at 15%, that's a good deal in my book "You finance grys are always talling about risk, but as long as we don't go banlinupt, borroning doesn"t add any risk at all. "Ed, I don't want to push my views on this-after all, you're the expert. We don't need to make a firm recommendation to the board until nest month. In the meantime, why don't you gst one of your new business graduates to look at the whole issue of how we should fnance the deal and what return we need to earn on these planes? Use the most recently available financial data from 2022 to help evaluate Mr. Johnson's arguments about the stocis issue and dividend payment as well as the reply of La's chief executive. Who is correct? What is the required rate of return on the new planes