A corporation is considering two plans for raising $3,000,000 to expand its oper
ID: 2417540 • Letter: A
Question
A corporation is considering two plans for raising $3,000,000 to expand its operations. The 12) first plan is to sell $3,000,000 of 6%, 10-year bonds at face value. The second plan is to sell
50,000 shares of $5 par value common stock for $3,000,000. Prior to any refinancing, the company has net income of $850,000 and 200,000 shares of common stock outstanding. Management believes the expanded operations will generate additional income of $366,000 before interest and taxes. The income tax rate is 40%.
a) Compute earnings per share assuming the bonds are issued.
b) Compute earnings per share assuming the stock is issued.
c) Based on these computations, which plan should be advised?
d) What other factors should be considered?
Explanation / Answer
When bonds are issued, additional interest must be paid for the issued bonds.
Details
Amount
Additional net income before interest and taxes
$ 366,000
Less: Interest ($3000000*0.06)
$ 180,000
Income before taxes
$ 186,000
Less: Income taxes @ 40%
$ 74,400
Net income (after taxes)
$ 111,600
Net income before re financing
$ 850,000
Total income
$ 961,600
Common stock outstanding
200000
Earnings per share (EPS)
$ 4.81
Details
Amount
Additional net income before interest and taxes
$ 366,000
Less: Interest
$ -
Income before taxes
$ 366,000
Less: Income taxes @ 40%
$ 146,400
Net income (after taxes)
$ 219,600
Net income before re financing
$ 850,000
Total income
$ 1,069,600
Common stock outstanding (200,000+50,000)
250,000
Earnings per share (EPS)
$ 4.28
c)
Based on these computations, determine the best plan :
Under plan 1, EPS is $4.81 which is more than plan 2 and it is advised to implement plan 1 when priority is EPS maximization.
d)
Determine other factors should be considered:
However, under plan 2, Total income is $1,069,600 which is higher than the income ($961,600) under plan 1. Therefore, the other factor is net income should be considered.
Details
Amount
Additional net income before interest and taxes
$ 366,000
Less: Interest ($3000000*0.06)
$ 180,000
Income before taxes
$ 186,000
Less: Income taxes @ 40%
$ 74,400
Net income (after taxes)
$ 111,600
Net income before re financing
$ 850,000
Total income
$ 961,600
Common stock outstanding
200000
Earnings per share (EPS)
$ 4.81
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