Oriole Company is considering these two alternatives for financing the purchase

Question

Oriole Company is considering these two alternatives for financing the purchase of a fleet of airplanes. It is estimated that the company will earn $805,000 before interest and taxes as a result of this purchase. The company has an estimated tax rate of 40% and has 92,500 shares of common stock outstanding prior to the new financing. Determine the effect on net income and earnings per share for issuing stock and issuing bonds. Assume the new shares or new bonds will be outstanding for the entire year.

Explanation / Answer

Answer:

Particulars Plan one Plan Two Issue stock Issue bonds Net income before tax & interest 805000 805000 Less: interest expense 0 275600 Net income before tax 805000 529400 Less: tax @40% 322000 211760 Net income after tax 483000 317640 Number of shares outstanding 145500 92500 EPS 3.32 3.43

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