Effect of Financing on Earnings Per Share Three different plans for financing a
ID: 2546325 • Letter: E
Question
Effect of Financing on Earnings Per Share
Three different plans for financing a $7,000,000 corporation are under consideration by its organizers. Under each of the following plans, the securities will be issued at their par or face amount, and the income tax rate is estimated at 40% of income.
Round the answers to nearest cent.
Instructions:
1. Determine for each plan the earnings per share of common stock, assuming that the income before bond interest and income tax is $14,000,000.
2. Determine for each plan the earnings per share of common stock, assuming that the income before bond interest and income tax is $6,650,000.
3. Regarding the three plans, which of the following statements is true?
Plan 1 Plan 2 Plan 3 10% bonds _ _ $3,500,000 Preferred 10% stock, $100 par _ $3,500,000 1,750,000 Common stock, $7 par $7,000,000 3,500,000 1,750,000 Total $7,000,000 $7,000,000 $7,000,000Explanation / Answer
Answer
Plan 1
Plan 2
Plan 3
Common Stock value at $7 par
$7000000
$3500000
$1750000
No. of common stock shares
1000000
500000
250000
Calculation of Net Income available for common stockholders
Plan 1
Plan 2
Plan 3
Income before bond interest
14000000
14000000
14000000
(-) Interest expense on bond
0
0
[3500000 x 10%] 350000
Income before income tax
14000000
14000000
13650000
(-) Income taxes at 40%
5600000
5600000
5460000
Income after income taxes
8400000
8400000
8190000
(-) Dividend share of preference stock
0
350000
175000
Income after tax available for common stockholders (A)
$8400000
$8050000
$8015000
No. of common stock shares (B)
1000000
500000
250000
Earning per share of common stock (A/B)
$8.4
$16.1
$32.06
Calculation of Net Income available for common stockholders
Plan 1
Plan 2
Plan 3
Income before bond interest
6650000
6650000
6650000
(-) Interest expense on bond
0
0
[3500000 x 10%] 350000
Income before income tax
6650000
6650000
6300000
(-) Income taxes at 40%
2660000
2660000
2520000
Income after income taxes
3990000
3990000
3780000
(-) Dividend share of preference stock
0
350000
175000
Income after tax available for common stockholders
$3990000
$3640000
$3605000
No. of common stock shares
1000000
500000
250000
Earning per share of common stock
$3.99
$7.28
$14.42
Plan 1
Plan 2
Plan 3
Common Stock value at $7 par
$7000000
$3500000
$1750000
No. of common stock shares
1000000
500000
250000
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