[ncbabygurl21]

Bailey Development Company has a capital structure consisting of $20 million of 10% debt and $30 million of common equity. The firm has 500,000 shares of common stock outstanding. Bailey is planning a major expansion and will need to raise $15 million. The firm must decide whether to finance the expansion with debt or equity. If equity financing is selected, common stock will be sold at $75 per share. If debt financing is chosen, 8% coupon bonds will be sold.

1. Before the expansion, what is interest payment for Bailey?

2. If Bailey finances the expansion with new debt, what is the TOTAL interest payment for the firm?

3. If Bailey finances the expansion with new equity, how many new shares will the firm issue to raise $15m? What are the total shares after expansion if the firm finances the expansion with new equity?

4. The firm's marginal tax rate is 34%. Determine the level of operating income at which Bailey would be indifferent between debt financing and equity financing (have same EPS).

5. For the previous question, if the firm decides to finance the expansion with a bond issue (new debt), and earns $8 million in operating income, what will be the firm’s earnings per share?