Problem: Spain Inn has a total value of $21 million. Its stock sells at $32 a share. At present, it has a loan of $5 million at 8% interest. It needs $3 million to renovate the building. It can get the financing by selling 100,000 shares of stock at $30 (net) per share, or by borrowing the money at 9% interest. The expected EBIT after the new financing is $3 million, with a standard deviation of $2 million.
Which method of financing will maximize its EPS? What is the probability that you have made the right choice.