The board of directors of Gibson Corporation is considering two plans for financ

Question

The board of directors of Gibson Corporation is considering two plans for financing the purchase of new plant equipment. Plan #1 would require the issuance of $4,000,000, 6%, 20-year bonds at face value. Plan #2 would require the issuance of 100,000 shares of $5 par value common stock which is selling for $40 per share on the open market. Gibson Corporation currently has 100,000 shares of common stock outstanding and the income tax rate is expected to be 30%. Assume that income before interest and income taxes is expected to be $800,000 if the new factory equipment is purchased. Instructions Prepare a schedule which shows the expected net income after taxes and the earnings per share on common stock under each of the plans that the board of directors is considering.

Explanation / Answer

In plan 1, interest expense is 4,000,000 * 6/100 = 240,000.

AMount left is 800,00 - 240,000 = 560,000

After 30% tax its 560,000 * 70/ 100 = 392,000

divident per share is $3.92

In Plan 2, interest expense is 0.

Amount left after tax is 800,000 * 70/100 = 560,000

so dividend per share is 560,000/200,000 = $2.8 per share

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