Three different plans for financing a $5,400,000 corporation are under considera

Question

Three different plans for financing a $5,400,000 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.

1.  Determine for each plan the earnings per share of common stock, assuming that the income before bond interest and income tax is $10,800,000. Enter answers in dollars and cents, rounding to the nearest cent.

2.  Determine for each plan the earnings per share of common stock, assuming that the income before bond interest and income tax is $5,130,000. Enter answers in dollars and cents, rounding to the nearest cent.

3. Discuss the advantages and disadvantages of each plan.

Plan 1 Plan 2 Plan 3 10% bonds _ _ $2,700,000 Preferred 10% stock, $40 par _ $2,700,000 1,350,000 Common stock, $5.40 par $5,400,000 2,700,000 1,350,000 Total $ 5,400,000 $ 5,400,000 $ 5,400,000

Explanation / Answer

Plan 1 Plan 2 Plan 3 Earnings before interest and tax    10,800,000.00    10,800,000.00    10,800,000.00 Less: Interest on bonds                            -                              -            270,000.00 Earnings before tax    10,800,000.00    10,800,000.00    10,530,000.00 Less: Tax      4,320,000.00      4,320,000.00      4,212,000.00 Eanings after tax      6,480,000.00      6,480,000.00      6,318,000.00 Less: Preferred Stock Dividend                            -            270,000.00          135,000.00 Earnings for common stock      6,480,000.00      6,210,000.00      6,183,000.00 No. of shares      1,000,000.00          500,000.00          250,000.00 EPS                       6.48                     12.42                     24.73

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