An engineer is working on a design project for a plastics manufacturing company
that has an after-tax cost of equity capital of 6% per year for retained earnings that
may be used to ] 00% equity finance the project. An alternative financing strategy
is to issue $4 mi ll ion worth of lO-year bonds that will pay 8% per year interest
on a quarterly basis. If the effective tax rate is 40%, which funding source has
the lower cost of capital?