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 6%, 10-year bonds at face value for $2,655,000.

Plan One Issue Stock

Plan Two Issue Bonds

$

It is estimated that the company will earn $771,000 before interest and taxes as a result of this purchase. The company has an estimated tax rate of 40% and has 119,600 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.

1. Issue 88,500 shares of common stock at $30 per share. (Cash dividends have not been paid nor is the payment of any contemplated.) 2.

Issue 6%, 10-year bonds at face value for $2,655,000.

Plan One Issue Stock

Plan Two Issue Bonds

Net income

$

$

Earnings per share

$

Explanation / Answer

Option 1

Issue 88,500 shares of common stock at $30 per share. (Cash dividends have not been paid nor is the payment of any contemplated.):-

Earnings before interest and Tax (EBIT)

(-) Tax @ 40 %

771000

308400

(B) Number of shares ( Existing + New)

= 119600 + 88500

Option 2

Issue 6%, 10-year bonds at face value for $2,655,000.

Earnings before interest and Tax (EBIT)

(-) Interest (2655000 * 6 %)

771000

159300

Earnings before Tax

(-) Tax @ 40%

611700

244680

(A) Earnings after Tax / Net income

Conclusion:-

Particulars Amount ($)

Earnings before interest and Tax (EBIT)

(-) Tax @ 40 %

771000

308400

(A) Eanings after Tax / Net income    462600

(B) Number of shares ( Existing + New)

= 119600 + 88500

208100 Earnings per share (EPS) = (A) / (B) 2.22

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