Alternative Financing Plans Brower Co. is considering the following alternative

Question

Alternative Financing Plans Brower Co. is considering the following alternative financing plans: Plan 1 Plan 2 Issue 10% bonds (at face value) Issue preferred $2.50 stock, $25 par Issue common stock, $10 par Income tax is estimated at 40% of income. Determine the earnings per share of common stock, assuming income before bond interest and income tax is $2,000,000. Enter answers in dollars and cents, rounding to the nearest whole cent. $4,000,000 $2,500,000 3,000,000 4,000,000 2,500,000 Earmings per share on common stock Earnings per share on common stock Plan 1 ) Plan 2

Explanation / Answer

Plan 1

Earnings before bond interest and income tax

$2000000

Deduct interest on bonds ($4,000,000 x 10%)

400000

Income before income tax

1600000

Less: income tax ($1,600,000 x 40%

640000

Net income

960000

Dividends on preferred stock

0

Available for dividends on common stock

960000

Shares of common stock outstanding

400000

Earnings per share on common stock ($960,000 / 400,000)

$2.40

Plan 2

Earnings before bond interest and income tax

$2000000

Deduct interest on bonds ($2,500,000 x 10%)

250000

Income before income tax

1750000

Deduct income tax ($1,750,000 x 40%)

700000

Net income

$1050000

Dividends on preferred stock ($3,000,000 / 25 x $2.50)

300000

Available for dividends on common stock

750000

Shares of common stock outstanding

250000

Earnings per share on common stock ($750,000 / 250,000)

$3.00

Earnings before bond interest and income tax

$2000000

Deduct interest on bonds ($4,000,000 x 10%)

400000

Income before income tax

1600000

Less: income tax ($1,600,000 x 40%

640000

Net income

960000

Dividends on preferred stock

0

Available for dividends on common stock

960000

Shares of common stock outstanding

400000

Earnings per share on common stock ($960,000 / 400,000)

$2.40

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