Working with a partner, assume that a company needs \($10\) million in additional long-term capital. It currently has no debt and \($40\) million in equity. The options are issuing a 10-year bond (with an interest rate of 7%) or selling \($10\) million in new equity. You expect next year's earnings before interest and taxes to be \($5\) million. (The company's tax rate is 21%.) Prepare a memo outlining the advantages and disadvantages of debt and equity financing. Using the numbers provided, prepare a numerical illustration of leverage similar to the one shown in Figure 17.2.

Figure 17.2:

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Return on Equity 35% 30% Leverage Company Equity Company 25% 20% 15% 10% 5% 0% -5% -10% -15% 0 5 10 15 20 Earnings ($ Millions)