Suppose I am the CEO of a 100%-equity-financed company, Boudro-o-Dirt, Inc., that
re-builds levees. I am considering taking on a project in New Orleans that will require a large initial investment on my firm’s part. Boudro-o-Dirt currently has 50,000 shares of equity outstanding and a $30 share price. The firm’s cost of equity is 12.5% and the marginal tax rate is 34%.
Having worked for a firm that went bankrupt several years ago, mainly due to a heavy debt-load, I have a very negative attitude towards the use of debt in Lots’ capital structure. However, I also know that I could start borrowing at 8%.
I have heard that you just read a couple of chapters about capitalizing with debt, so I decide to hire you to advise me about financing all or part of this project with debt. What should I be aware of and concerned about as I make my decision about 1) the pros and cons of using debt or not, and 2) how much debt to use?