Effect of Financing on Earnings Per Share Three different plans for financing a

Question

Effect of Financing on Earnings Per Share Three different plans for financing a $4,800,000 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 _ _ $2,400,000 Preferred 10% stock, $40 par _ $2,400,000 1,200,000 Common stock, $4.8 par $4,800,000 2,400,000 1,200,000 Total $ 4,800,000 $ 4,800,000 $ 4,800,000 Required: 1. Determine for each plan the earnings per share of common stock, assuming that the income before bond interest and income tax is $9,600,000. Enter answers in dollars and cents, rounding to the nearest cent. Earnings Per Share on Common Stock 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 $4,560,000. Enter answers in dollars and cents, rounding to the nearest cent. Earnings Per Share on Common Stock Plan 1 $ Plan 2 $ Plan 3 $ 3. The principal advantage of Plan 1 is that it involves only the issuance of common stock, which does not require a periodic interest payment or return of principal, and a payment of preferred dividends is not required.

Explanation / Answer

A. Plan 1 Plan 2 Plan 3 Income 9600000 9600000 9600000 Interest 240000 360000 0 Income before tax 9360000 9240000 9600000 Tax@40% 3744000 3696000 3840000 Net income 5616000 5544000 5760000 Number of shares 500000 250000 1000000 EPS 11.232 22.176 5.76 A. Plan 1 Plan 2 Plan 3 Income 4560000 4560000 4560000 Interest 240000 360000 0 Income before tax 4320000 4200000 4560000 Tax@40% 1728000 1680000 1824000 Net income 2592000 2520000 2736000 Number of shares 500000 250000 1000000 EPS 5.184 10.08 2.736

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