The managers of Martin House are paid a salary and share in a bonus that is determined at the end of each year. The total bonus is determined by multiplying the company’s income from operations by 25 percent. The bonus is not considered an operating expense. Interest on bor¬ rowed funds is considered an operating expense when computing the bonus. During 1997 the company decided to expand its plant facility. The estimated cost of the expansion was $1 million. To raise the necessary funds, the company could either borrow $1 million at an annual interest rate of 8 percent or issue 50,000 shares of common stock at $20 each. The company raised the funds using one of these two methods, and income from opera¬ tions (excluding any interest charges) for 1997 was reported as follows. Operating revenues $6,800,000 Operating expenses (excluding interest) 5,600,000 Income from operations $1,200,000 REQUIRED:

a. Assume that on January 1, 1997, Martin House borrowed the $1 million. Compute the total bonus shared by the company’s managers.

b. Assume that on January 1, 1997, Martin House issued common stock to raise the $1 mil¬ lion. Compute the total bonus shared by the company’s managers.

c. Why might management choose to issue equity instead of borrow the $1 million? Is such a decision necessarily in the best interest of the company’s stockholders?

d. Repeat

(a) and

(b) above, assuming the interest expense is not considered an operating expense when computing the bonus.