Alternative Financing Plans Frey Co. is considering the following alternative fi

Question

Alternative Financing Plans

Frey Co. is considering the following alternative financing plans:

Plan 1

Plan 2

Issue 10% bonds (at face value)

$1,320,000

$660,000

Issue preferred $1 stock, $10 par

—

1,100,000

Issue common stock, $5 par

1,320,000

880,000

Income tax is estimated at 40% of income.

Determine the earnings per share on common stock, assuming that income before bond interest and income tax is $1,056,000.

Enter answers in dollars and cents, rounding to the nearest cent.

Plan 1

$ Earnings per share on common stock

Plan 2

$ Earnings per share on common stock

Plan 1

Plan 2

Issue 10% bonds (at face value)

$1,320,000

$660,000

Issue preferred $1 stock, $10 par

—

1,100,000

Issue common stock, $5 par

1,320,000

880,000

Explanation / Answer

Solution:-

Earnings per share on common stock for plan 1 :-

= $1,320,000 * 10%

= $1,32,000

= $1,056,000 - $1,32,000

= $924,000

= $924,000 * 40%

= $369,600

=924,000 - 369,600

= $554,400

Number of common stock = $1,320,000 / $5

= $264,000

Number of common stock = $264,000

Earning per Share = net income / number of common stock

= $554,400 / $264,000

= $2.1

Earning per Share = $2.1

Earnings per share on common stock for plan 2 :-

= $660,000 * 10%

= $66,000

= $1,056,000 - $66,000

= $990,000

= $990,000 * 40%

= $396,000

= $990,000 - $396,000

= $594,000

$1,100,000 / 10

= $1,10,000

= $594,000 - $1,10,000

= $484,000

Number of common stock = $880,000 / $5

= $176,000

Number of common stock =  $176,000

Earning per share = $484,000 / $176,000

= $2.75

Earning per share = $2.75

Calculations Amount Earnings before bond interest and income tax $1,056,000 Bond interest

= $1,320,000 * 10%

= $1,32,000

$1,32,000 Net income before taxes

= $1,056,000 - $1,32,000

= $924,000

$924,000 Income tax

= $924,000 * 40%

= $369,600

$369,600 Net income

=924,000 - 369,600

= $554,400

$554,400

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