Northeast Airlines is considering two alternatives for the financing of a purcha

Question

Northeast Airlines is considering two alternatives for the financing of a purchase of a fleet of airplanes. These two alternatives are:
Issue 60,000 shares of common stock at $45 per share. (Cash dividends have not been paid nor is the payment of any contemplated).

Issue 10%, 10-year bonds at par for $2,700,000.

It is estimated that the company will earn $800,000 before interest and taxes as a result of this purchase. The company has an estimated tax rate of 30% and has 90,000 shares of common stock outstanding prior to the new financing.
Instructions

Determine the effect on net income and earnings per share for these two methods of financing. (If answer is zero, please enter 0. Do not leave any fields blank. Round earnings per share to 2 decimal places, e.g. 10.50.)

Explanation / Answer

In case of stock issue Net income =($800,000)*(1-30%) =560000 EPS=560000/(90,000+60,000) = $3.73 In case of bond issue Net income =($800,000-10%*$2,700,000)*(1-30%) = $371,000 EPS= $371,000/(90,000) = $4.12

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