The Fly Eagles Fly Corporation (FEFC) has determined that they need to raise an additional $1,400,000 to support the projected level of operations in the coming year. These funds can be raised through debt with a bank loan that has already been approved at an interest rate of 9% OR by the sale of additional shares of common stock.

Information about FEFC's current securities and the market is as follows:

Bonds Common Stock Market

2000 bonds outstanding 100,000 shares outstanding Treasury Bill yield = 5%

10% coupon rate, $1000 par value Current market price = $58 Market risk premium = 7%

Maturity date: December 19, 2027 FEFC's beta = 1.7

Current market price = $1018.52

FEFC has forecasted their earnings before interest and tax (EBIT) to be $1,800,000 in the coming year. The marginal tax rate is 30%. All earnings will be paid out as dividends.

Ignoring flotation costs, determine whether FEFC should raise the additional funds by issuing equity or taking out the loan by answering the following questions:

a. Qualitatively, what general factors should FEFC consider in making its decision between issuing debt or equity?

b. Determine the weighted average cost of capital (WACC) if FEFC raises the funds with debt.

c. Determine the WACC if FEFC raises the funds with equity.

d. Determine earnings per share (EPS) for the coming year if the firm raises the necessary funds through the bank loan.

e. Determine EPS for the coming year if the firm raises the necessary funds by issuing new common stock.

f. At what breakeven EBIT level will EPS be the same under the two different capital structures being considered?

g. Based on your answers in (a) through (f), should FEFC borrow the additional funds or issue new common shares? Why?

h. Is it reasonable to assume that EBIT will be the same if FEFC raises the additional capital with debt or with equity? Explain.

i. Is it reasonable to assume that the component costs of debt and equity will be the same if FEFC raises the additional capital with debt or with equity? Explain.