DEBT AND EQUITY
The Simla Corporation is considering how to finance its latest project, construction of a new fertilizer plant. The plant is expected to cost $3 million dollars, and it will generate $700,000 each year of its five year expected life.
The options for financing are either to issue bonds (debt) or issue additional stock (equity). The current interest rate for bond financing is 8%, and the company would have little trouble finding institutions eager to buy such bonds. To raise $3 million in the equity market would require the sale of 30,000 additional shares of common stock. Currently, there are only 100,000 shares outstanding, mostly held by the Simla family.
In addition to the income from the proposed plant, the Simla Corporation foresees other pretax earnings of $800,000 per year for the next five years. The tax rate for the corporation is 40%.
Please advise Seymour Fish, the V. P. finance for the Simla Corporation, which alternative is financially preferable. What other considerations, other than financial, may go into the decision on which option to choose