Exercise 11-14 Ivanhoe Company is considering these two alternatives for financi

Question

Exercise 11-14 Ivanhoe Company is considering these two alternatives for financing the purchase of a fleet of airplanes. 1. Issue 58,000 shares of common stock at $41 per share. (Cash dividends have not been paid nor is the payment of any contemplated.) 2, Issue 1296, 10-year bonds at face value for $2,378,000 It is estimated that the company will earn $815,000 before interest and taxes as a result of this purchase. The company has an estimated tax rate of 30% and has 97,500 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

Explanation / Answer

Plan 1 has no P&L effect, so earnings will be:

Net Income Before Tax $815000
Less: Tax @ 30%         $244500

Net Income After Tax = $570500

But the number of shares increase from 97500 to 155500

Therefore Earnings Per Share = ($570500 / 155500)= $3.66

Plan 2 carries with it an interest expense that will lower net income.

Under this scenario, the interest would be ($2378000 X 10%) = $237800 per year

So Net Income After tax is computed as:

Net Income Before Interest and Tax $815000
Less : Interest of                               $237800

Net income Before Tax = ($815000 - $237800) = $577200

Less Income Tax of ($577200 X 30%) = $173160

Net Income After Tax = ($577200 - $173160) = $404040

Earnings Per Share under this scenario equals ($404040 / 97500) = $4.14

So even though scenario 2 results in much less net income, the earnings per share figure is higher by $0.48.

Related Questions

Navigate

• Browse (All)
• Browse E
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.