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Copper Inc. is currently financed by equity only. The forecast of Copper's net income for the coming year is shown below (in thousands of dollars):

EBIT $2,000

Interest expense 0

Income before tax 2,000

Taxes -600

Net income $1,400

The corporate tax rate is 30%. Copper's managers are expected to waste 10% of its net income on needless perks, pet projects, and other expenditures that do not contribute to the firm. All remaining income will be returned to shareholders through dividends and share repurchases. Copper is considering raising funds by issuing debt. If debt is issued, an interest expense of $400,000 needs to be incurred in the coming year.

(i)If Copper does not issue debt, how much will shareholders receive in the coming year in the form of dividends and share repurchases?

(ii)With the issue of new debt, what is the total amount Copper needs to pay to all investors (including both shareholders and debt holders) in the coming year?

(iii)Compare answers in (i) and (ii). Based on the result, discuss one benefit of debt financing.

pur-new-sol

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