Question: Is it right? M K 1 ALT-FINANCIAL LEVERAGE 2 3. Choose Exercise 4 5 Cornwall Corporation has two alternatives for raising money from financing: 6

Is it right? Is it right? M K 1 ALT-FINANCIAL LEVERAGE 2 3. Choose Exercise

M K 1 ALT-FINANCIAL LEVERAGE 2 3. Choose Exercise 4 5 Cornwall Corporation has two alternatives for raising money from financing: 6 7 Plan 1 Plan 2 8 Issue 10% bonds at face value: $2,000,000 9 Issue Common Stock, $10 par $3,000,000 $1,000,000 10 $3,000,000 $3,000,000 Total Financing 11 12 Earnings before interest and income tax $750,000 $750,000 25.00% Rate of Return on Financing 13 Income Tax Rate = 20% 14 Shares Issued 300,000 100,000 shares 15 16 Plan 1 Plan 2 17 EARNINGS BEFORE INTEREST AND TAXES $750,000 $750,000 18 DEDUCT BOND INTEREST $200,000 19 INCOME BEFORE INCOME TAX $750,000 $550,000 20 21 INCOME TAX $150,000 $110,000 22 NET INCOME $600,000 $440,000 23 24 SHARES OF COMMON STOCK OUTSTANDING 300,000 10,000 shares 25 EARNINGS PER SHARE $2.00 $4.40 26 27 If the rate of return on Financing > Bond Interest Rate, the borrowing is advantageous. (Favorable Financial Leverage) 28 If the rate of return on Financing

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