You have been hired by a company to provide advice on capital structure decisions. One day the CEO puts forward the following arguments to you:

a. I have estimated a cost of debt of 4% and a cost of equity of 15% for my firm. As debt is cheaper than equity, I would like to issue a bond and buy back shares to reduce the overall cost of capital of my firm.

b. The leverage from the bond issuance will increase my firms expected earnings per share (EPS) which should lead to an increase in the firms stock price. That will benefit all shareholders, including myself, since I own 5% of the shares.

Assuming perfect capital markets, do you agree with the CEOs arguments? Explain your reasoning.