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 $834,800 before interest and taxes as a result of this purchase. The company has an estimated tax rate of 40% and has 95,800 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.)

1. Issue 60,500 shares of common stock at $50 per share. (Cash dividends have not been paid nor is the payment of any contemplated.) 2. Issue 13%, 13-year bonds at face value for $3,025,000.

Explanation / Answer

Plan 1 Plan 2 Income before interest and tax 834800 834800 less:Interest           (3025000*.13) - -393250 Income before tax 834800 441550 less:Taxes    (.40 * income before tax) -333920 -176620 net income 500880 264930 outstanding shares 95800+60500 = 156300 95800 Earning per share 500880 /156300 =$ 3.20 264930/95800 = $2.77

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