Rachels Crab Heaven (RCH) supplies crabs, fish, and clams to restaurants along the east coast. Rachel is sole owner and chief executive. She currently has one fishing vessel but is considering investing in one that would increase her daily harvest two to three fold. Rachel estimates the new vessel would generate an operating cash flow of $207,000 per year for eight years. The vessel has an initial investment of $1,250,000. Rachel will borrow the entire amount from First Bank at 6.2%.

Suppose instead of a bank loan, Rachel decided to finance the purchase with both a bank loan and an equity issue. Describe the differences between the two sources of capital and the implications for capital structure as described by MM and the optimal level of debt.