Differentiate financing with debt vs. equity
Response to the following problem:
Hillside Medical Goods is embarking on a massive expansion. Assume plans call for opening 20 new stores during the next two years. Each store is scheduled to be 30% larger than the company's existing locations, offering more items of inventory and with more elaborate displays. Management estimates that company operations will provide $1 million of the cash needed for expansion. Hillside Medical must raise the remaining $6.75 million from outsiders. The board of directors is considering obtaining the $6.75 million either through borrowing at 6% or by issuing an additional 100,000 shares of common stock. This year the company has earned $2 million before interest and taxes and has 100,000 shares of $1-par common stock outstanding. The market price of the company's stock is $67.50 per share. Assume that income before interest and taxes is expected to grow by 20% each year for the next two years. The company's marginal income tax rate is 35%.