Penny Arcades, Inc., is trying to decide between the following two alternatives

Question

Penny Arcades, Inc., is trying to decide between the following two alternatives to finance its new $30 million gaming center:

a. Issue $30 million of 5% bonds at face amount.
b. Issue 1 million shares of common stock for $30 per share.

1. Assuming bonds or shares of stock are issued at the beginning of the year, complete the income statement for each alternative. (Enter your answer in dollars, not millions. (i.e., $5.5 million should be entered as 5,500,000). Round your "Earnings per Share" to 2 decimal places. Round your "Earnings per Share" to 2 decimal places.)

Issue Bonds

Issue stock  

Operating income

10,500,0000

10,500,5000

Interest expense (bonds only)

Income before tax

Income tax expense (40%)

Net Income

Number of shares

3,500,0000

4,500,000

Earnings per share

2. Which alternative results in the highest earnings per share?

Issue bonds

Issue stock

Issue Bonds

Issue stock  

Operating income

10,500,0000

10,500,5000

Interest expense (bonds only)

Income before tax

Income tax expense (40%)

Net Income

Number of shares

3,500,0000

4,500,000

Earnings per share

Explanation / Answer

Issue Bonds Issue stock   Operating income 1050,00,000.00 1050,00,000.00 Less:Interest expense (bonds only) (30000000*0.05)       15,00,000.00 0 Income before tax (Operating income- interest) 1035,00,000.00 1050,00,000.00 Less:Income tax expense (40%)     414,00,000.00     420,00,000.00 Net Income ( Income before tax-income tax)     621,00,000.00     630,00,000.00 Number of shares     350,00,000.00     450,00,000.00 Earnings per share (Net income/ Number of shares) 1.77 1.40 2) Issue bonds will result in highest earning per share because number of shares in case of issue of bonds is less. So answer is issue bonds.

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