Three different plans for financing a $5,600,000 corporation are under considera

Question

Three different plans for financing a $5,600,000 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 $11,200,000. Enter answers in dollars and cents, rounding to the nearest cent.

Plan 1

Plan 2

Plan 3

2. Determine for each plan the earnings per share of common stock, assuming that the income before bond interest and income tax is $5,320,000. Enter answers in dollars and cents, rounding to the nearest cent.

Plan 1

Plan 2

Plan 3

Plan 1 Plan 2 Plan 3 10% bonds _ _ $2,800,000 Preferred 5% stock, $80 par _ $2,800,000 1,400,000 Common stock, $5.60 par $5,600,000 2,800,000 1,400,000 Total $ 5,600,000 $ 5,600,000 $ 5,600,000

Explanation / Answer

Solution: Requirement 1.

EPS = $0.83

Requirement 2:

1. Determine for each plan the earnings per share of common stock, assuming that the income before bond interest and income tax is $11,200,000. Enter answers in dollars and cents, rounding to the nearest cent. Plan 1 EBIT = $11,200,000 Income tax = (11,200,000 x 40%) = $4,480,000 Net income = $11,200,000 - $4,480,000 = $6,720,000 $5,600,000 / 5.60 (number of common shares) = $1,000,000 Earnings Per Share (EPS) = Net Income - Preferred Dividends Weighted Average Common Shares Outstanding Net income = $6,720,000 Preferred Dividends = $1,000,000 x 5% ÷ 80 = 625 Weighted Average Common Shares Outstanding = $1,000,000 EPS = $6,720,000 - 625 ÷ $1,000,000 EPS = $6,719,375 ÷ $1,000,000 EPS = $6.719 or $6.72 Plan 2 EBIT = $11,200,000 Income tax = (11,200,000 x 40%) = -4,480,000 Net income = $11,200,000 - $4,480,000 = $6,720,000 Preferred dividends = $2,800,000 x 5% = $140,000 Net Income - Preferred dividends= $6,720,000 - $140,000 = $6,580,000 $2,800,000 / 5.60 (number of common shares) = $5,000,000 Earnings Per Share (EPS) = Net Income - Preferred Dividends Weighted Average Common Shares Outstanding Net income = $6,720,000 Preferred Dividends = $140,000 Weighted Average Common Shares Outstanding = $5,000,000 EPS = $6,580,000 ÷ $5,000,000 EPS = $13 Plan 3 EBIT = $11,200,000 Bond interest = 2,800,000 x 10% = $280,000 EBIT - Bond Interest = $11,200,000 - $280,000 = $10,920,000 Income tax = ($10,920,000 x 40%) = $4,368,000 Net income = $10,920,000 - $4,368,000 = $6,552,000 Preferred dividends = $1,400,000 x 5% = $70,000 Net Income - Preferred dividends= $6,552,000 - $70,000 = $6,482,000 $1,400,000 / 5.60 (number of common shares) = $7,840,000 Earnings Per Share (EPS) = Net Income - Preferred Dividends Weighted Average Common Shares Outstanding Net income = $6,552,000 Preferred Dividends = $70,000 Net Income - Preferred dividends= $6,552,000 - $70,000 = $6,482,000 Weighted Average Common Shares Outstanding = $7,840,000 EPS = $6,482,000 ÷ $7,840,000

EPS = $0.83

Requirement 2:

2. Determine for each plan the earnings per share of common stock, assuming that the income before bond interest and income tax is $5,320,000. Enter answers in dollars and cents, rounding to the nearest cent. Plan 1 EBIT =   $5,320,000 Income tax = (5,320,000 x 40%) = $2,128,000 Net income = $5,320,000 - $2,128,000 = $3,192,000 $5,600,000 / 5.60 (number of common shares) = $1,000,000 Earnings Per Share (EPS) = Net Income - Preferred Dividends Weighted Average Common Shares Outstanding Net income = $3,192,000 Preferred Dividends = $1,000,000 x 5% ÷ 80 = 625 Weighted Average Common Shares Outstanding = $1,000,000 EPS = $3,192,000 - 625 ÷ $1,000,000 EPS = $3,119,375 ÷ $1,000,000 EPS = $3.19 Plan 2 EBIT =   $5,320,000 Income tax = (5,320,000 x 40%) = $2,128,000 Net income = $5,320,000 - $2,128,000 = $3,192,000 Preferred dividends = $2,800,000 x 5% = $140,000 Net Income - Preferred dividends= $3,192,000 - $140,000 = $3,052,000 $2,800,000 / 5.60 (number of common shares) = $5,000,000 Earnings Per Share (EPS) = Net Income - Preferred Dividends Weighted Average Common Shares Outstanding Net income = $3,192,000 Preferred Dividends = $140,000 Net Income - Preferred dividends= $3,192,000 - $140,000 = $3,052,000 Weighted Average Common Shares Outstanding = $5,000,000 EPS = $3,052,000 ÷ $5,000,000 EPS = $0.61 Plan 3 EBIT =   $5,320,000 Bond interest = 2,800,000 x 10% = $280,000 EBIT - Bond Interest = $5,320,000 - $280,000 = $5,040,000 Income tax = ($5,040,000 x 40%) = $2,016,000 Net income = $5,040,000 - $2,016,000 = $3,024,000 Preferred dividends = $1,400,000 x 5% = $70,000 Net Income - Preferred dividends= $3,024,000 - $70,000 = $2,954,000 $1,400,000 / 5.60 (number of common shares) = $7,840,000 Earnings Per Share (EPS) = Net Income - Preferred Dividends Weighted Average Common Shares Outstanding Net income = $3,024,000 Preferred Dividends = $70,000 Net Income - Preferred dividends= $3,024,000 - $70,000 = $2,954,000 Weighted Average Common Shares Outstanding = $7,840,000 EPS = $2,954,000 ÷ $7,840,000 EPS = $0.38

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