Effect of Financing on Earnings Per Share Three different plans for financing an
ID: 2335334 • Letter: E
Question
Effect of Financing on Earnings Per Share
Three different plans for financing an $5,000,000 corporation are under consideration by its organizers. Under each of the following plans, the securities will be issued at their par or face amount, and the income tax rate is estimated at 40% of income:
Required:
1. Determine the earnings per share of common stock for each plan, assuming that the income before bond interest and income tax is $10,000,000. Enter answers in dollars and cents, rounding to the nearest cent.
2. Determine the earnings per share of common stock for each plan, assuming that the income before bond interest and income tax is $4,750,000. Enter answers in dollars and cents, rounding to the nearest cent.
Plan 1 Plan 2 Plan 3 10% bonds _ _ $2,500,000 Preferred 5% stock, $80 par _ $2,500,000 1,250,000 Common stock, $5 par $5,000,000 2,500,000 1,250,000 Total $ 5,000,000 $ 5,000,000 $ 5,000,000Explanation / Answer
Plan 1
Plan 2
Plan 3
Income Before Interest and Taxes
$10,000,000
$10,000,000
$10,000,000
Less: Interest 10% x $2,500,000
0
0
$250,000
Income Before Taxes
$10,000,000
$10,000,000
$9,750,000
Income tax at 40%
$4,000,000
$4,000,000
$3,900,000
Profit after tax
$6,000,000
$6,000,000
$5,850,000
Less: Preference dividend
$0
$125,000
$62,500
Net Income
$6,000,000
$5,875,000
$5,787,500
Number of shares outstanding
1,000,000
500,000
250,000
Earnings per share
$6
$11.75
$23.15
EPS rounded off to nearest dollar –
Plan1 = $6
Plan2 = $12
Plan3 = $23
Plan2 = 5% x $2,500,000 = $125,000
Plan3 = 5% x $1,250,000 = $62,500
Plan1 = $5,000,000/$5 = 1,000,000
Plan2 = $2,500,000/$5 = 500,000
Plan3 = $1,250,000/$5 = 250,000
Plan1 = $6,000,000/1,000,000 = $6 per share
Plan2 = $5,875,000/500,000 = $11.75 per share
Plan3 = $5,787,500/250,000 = $23.15 per share
Plan 1
Plan 2
Plan 3
Income Before Interest and Taxes
$4,750,000
$4,750,000
$4,750,000
Less: Interest 10% x $2,500,000
0
0
$250,000
Income Before Taxes
$4,750,000
$4,750,000
$4,500,000
Income tax at 40%
$1,900,000
$1,900,000
$1,800,000
Profit after tax
$2,850,000
$2,850,000
$2,700,000
Less: Preference dividend
$0
$125,000
$62,500
Net Income
$2,850,000
$2,725,000
$2,637,500
Number of shares outstanding
1,000,000
500,000
250,000
Earnings per share
$2.85
$5.45
$10.55
EPS rounded off
$3
$5
$11
Plan2 = 5% x $2,500,000 = $125,000
Plan3 = 5% x $1,250,000 = $62,500
Plan1 = $5,000,000/$5 = 1,000,000
Plan2 = $2,500,000/$5 = 500,000
Plan3 = $1,250,000/$5 = 250,000
Plan1 = $2,850,000/1,000,000 = $2.85 per share
Plan2 = $2,725,000/500,000 = $5.45 per share
Plan3 = $2,637,500/250,000 = $10.55 per share
Plan 1
Plan 2
Plan 3
Income Before Interest and Taxes
$10,000,000
$10,000,000
$10,000,000
Less: Interest 10% x $2,500,000
0
0
$250,000
Income Before Taxes
$10,000,000
$10,000,000
$9,750,000
Income tax at 40%
$4,000,000
$4,000,000
$3,900,000
Profit after tax
$6,000,000
$6,000,000
$5,850,000
Less: Preference dividend
$0
$125,000
$62,500
Net Income
$6,000,000
$5,875,000
$5,787,500
Number of shares outstanding
1,000,000
500,000
250,000
Earnings per share
$6
$11.75
$23.15
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