Atlantic Airlines is considering these two alternatives for financing the purcha

Question

Atlantic Airlines is considering these two alternatives for financing the purchase of a fleet of airplanes.

It is estimated that the company will earn $815,900 before interest and taxes as a result of this purchase. The company has an estimated tax rate of 30% and has 97,100 shares of common stock outstanding prior to the new financing.

Determine the effect on net income and earnings per share for issuing stock and issuing bonds. Assume the new shares or new bonds will be outstanding for the entire year. (Round earnings per share to 2 decimal places, e.g. $2.66.)

Plan One Issue Stock

Plan Two Issue Bonds

1. Issue 52,200 shares of common stock at $50 per share. (Cash dividends have not been paid nor is the payment of any contemplated.) 2. Issue 15%, 14-year bonds at face value for $2,610,000.

Explanation / Answer

Plan Two Issue Bonds Plan One Issue Stock Income before interest and taxes $815,900 $815,900 Interest ($2,610,000 X 15%) ------- 391,500 Income before taxes 815,900 424,400 Income tax expense (30%) 244,770 127,320 Net income 571,130 297,080 Outstanding shares 149,300 97,100 Earnings per share $3.83 $3.06

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