Three different plans for financing a $40,000,000 corporation are under consider

Question

Three different plans for financing a $40,000,000 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:



___________Plan 1____________Plan 2_________________Plan 3__________
10% bonds ---- ---- $20,000,000
Preferred $2.50 stock, $50 par---- $20,000,000 10,000,000
Common stock, $25 par *$40,000,000 20,000,000 10,000,000
Total $40,000,000 $40,000,000 40,000,000
Instructions:
1. Determine for each plan the earnings per share of common stock, assumin g
that the income before bond interest and income tax is $6,000,000.
2. Determine for each plan the earnings per share of common stock, assumin g
that the income before bond interest and income tax is $3,200,000.
3. Discuss the advantages and disadvantages of each plan.

this is what I came up with:
Plan 1 Plan 2 Plan 3
Earnings before bond interest and income tax $6,000,000 $6,000,000 $6,000,000
Bond interest 0 2,000,000 1,000,000
Balance 6,000,000 4,000,000 5,000,000
Income Tax 2,400,000 1,600,000 2,000,000
Net Income 3,600,000 2,400,000 3,000,000
Dividends on preferred stock 0 0 0
Earnings available for common stock 3,600,000 2,400,000 3,000,000
Number of common shares 40,000,000 20,000,000 40,000,000
Earnings per share on common stock .09 .12 .075

Explanation / Answer

Net income after tax (no interest): 1,200,000 (2,000,000 x .60) Net income after interest and taxes: 900,000 (1,500,000 x .60) 1) Plan 1: $ 1.20 (1,200,000 / 1,000,000) Plan 2: $ 1.40 (1,200,000 - 500,000 (pref div)) / 500,000 Plan 3: $ 1.60 (900,000 - 500,000) / 250,000

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