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

Question

Gilliland Airlines is considering two alternatives for the financing of a purchase of a fleet of airplanes. These two alternatives are: Issue 76,950 shares of common stock at $30 per share. (Cash dividends have not been paid nor is the payment of any contemplated.) Issue 8%, 10-year bonds at face value for $2,308,500. It is estimated that the company will earn $817,000 before interest and taxes as a result of this purchase. The company has an estimated tax rate of 40% and has 118,000 shares of common stock outstanding prior to the new financing. Determine the effect on net income and earnings per share for these two methods of financing.

Explanation / Answer

SAolution.

Determine the effect on net income and earnings per share for (a) issuing stock
Net Income
(817,000 x 60% = $490,200 net income
Earnings Per Share
590,200 / 194,950 shares = $3.02 EPS

(b) issuing bonds
2,308,500 x 8% = $184,680 interest expense
Net Income
(817,000 - 184,680) x 60% = $379,392 net income
Earnings Per Share
$379,392 / 118,000 shares = $3.21 EPS

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