The Barnard Corporation needs additional cash to improve its facilities. It can borrow $1,200,000 from a bank at 7.5 percent interest for 10 years, with a balloon payment of the entire principal at the end of the 10-year period. It can issue $1,200,000 in 10-year corporate bonds paying 6 percent interest, but it will incur underwriting costs related to issuing the bonds of $120,000. Its third alternative is to issue $1,200,000 in preferred stock that will require annual dividend payments of 5 percent. The stock will be callable at the end of 10 years at 102 (meaning Barnard will pay a redemption premium equal to 2% at that time). The costs of issuing the preferred stock will only be $60,000. Which alternative should the corporation choose? The corporation’s effective tax rate is expected to be 30 percent for all relevant years, and the corporation uses a 6 percent discount rate for all of its financial analyses. Completely analyze the question and explain your answer.
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