Three different plans for financing a $8,000,000 corporation are under considera
ID: 2380147 • Letter: T
Question
Three different plans for financing a $8,000,000 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 for each plan the earnings per share of common stock, assuming that the income before bond interest and income tax is $16,000,000. Enter answers in dollars and cents, rounding to the nearest cent.
2. Determine for each plan the earnings per share of common stock, assuming that the income before bond interest and income tax is $7,600,000. Enter answers in dollars and cents, rounding to the nearest cent.
Plan 1 Plan 2 Plan 3 10% bonds _ _ $4,000,000 Preferred 5% stock, $80 par _ $4,000,000 2,000,000 Common stock, $8.00 par $8,000,000 4,000,000 2,000,000 Total $ 8,000,000 $ 8,000,000 $ 8,000,000Explanation / Answer
1.
Plan 1
Interest = 0
Dividend on preferred stock = 0
No of common shares = 8,000,000/8 = 1,000,000
EBIT = $16,000,000
EPS = EBIt*(1-t)/No of shares = (16,000,000)*(1-40%)/1,000,000 = $9.6
Plan 2
Interest = 0
No of preferred shares = 4,000,000/80 =50000
Dividend on preferred stock = 5%*80*50000 =$200,000
No of common shares = 4,000,000/8 = 500,000
EBIT = $16,000,000
Net income = (EBIt-Interest)*(1-t)
Earnings available for common stock = Net income - Dividend on preferred stock
Earnings available for common stock = 16,000,000*(1-40%)-200,000 =$9400000
EPS =Earnings available for common stock/No of shares =9400000/500,000 = $18.80
Plan3
Interest = 10%*4,000,000 = 400,000
No of preferred shares = 2,000,000/80 =25000
Dividend on preferred stock = 5%*80*25000 =$100,000
No of common shares = 2,000,000/8 = 250,000
EBIT = $16,000,000
Net income = = (EBIt-Interest)*(1-t)
Earnings available for common stock = Net income - Dividend on preferred stock
Earnings available for common stock = (16,000,000-400,000)*(1-40%)-100,000 =$9260000
EPS =Earnings available for common stock/No of shares =9260000/250,000 = $37.04
2.
Plan 1
Interest = 0
Dividend on preferred stock = 0
No of common shares = 8,000,000/8 = 1,000,000
EBIT = $7,600,000
EPS = EBIt*(1-t)/No of shares = (7,600,000)*(1-40%)/1,000,000 = $4.56
Plan 2
Interest = 0
No of preferred shares = 4,000,000/80 =50000
Dividend on preferred stock = 5%*80*50000 =$200,000
No of common shares = 4,000,000/8 = 500,000
EBIT = $16,000,000
Net income = (EBIt-Interest)*(1-t)
Earnings available for common stock = Net income - Dividend on preferred stock
Earnings available for common stock = 7,600,000*(1-40%)-200,000 =$4360000
EPS =Earnings available for common stock/No of shares =4360000/500,000 = $8.72
Plan3
Interest = 10%*4,000,000 = 400,000
No of preferred shares = 2,000,000/80 =25000
Dividend on preferred stock = 5%*80*25000 =$100,000
No of common shares = 2,000,000/8 = 250,000
EBIT = $16,000,000
Net income = = (EBIt-Interest)*(1-t)
Earnings available for common stock = Net income - Dividend on preferred stock
Earnings available for common stock = (7,600,000-400,000)*(1-40%)-100,000 =$4220000
EPS =Earnings available for common stock/No of shares =4220000/250,000 = $16.88
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