ONLY ANSWER (C)

Aristocrat, Baker and Chef have formed Chez Guevara, Inc.

Chez requires at least $1,800,000 of additional capital in order to renovate the building, acquire new equipment and provide working capital. It has negotiated a $900,000 loan from Friendly National Bank on the following terms: interest will be payable at two points above the prime rate, determined semi-annually, with principal due in ten years and the loan will be secured by a mortgage on the renovated restaurant building.

Evaluate the following alternative proposals for raising the additional $900,000 needed to commence business, focusing on the possibility that the IRS will reclas sify corporate debt instruments as equity.

(a) Aristocrat, Baker and Chef each will loan Chez $300,000, and each will take back a $300,000 five-year corporate note with variable interest payable at one point below the prime rate, determined annually.

(b) Same as (a), except that the $900,000 loan from Friendly National Bank will be unsecured but personally guaranteed by Aristocrat, Baker and Chef, who will be jointly and severally liable.