Effect of Financing on Earnings Per Share Three different plans for financing an

Question

Effect of Financing on Earnings Per Share

Three different plans for financing an $8,700,000 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:

Required:

1. Determine the earnings per share of common stock for each plan, assuming that the income before bond interest and income tax is $17,400,000. Enter answers in dollars and cents, rounding to the nearest cent.

2. Determine the earnings per share of common stock for each plan, assuming that the income before bond interest and income tax is $8,265,000. Enter answers in dollars and cents, rounding to the nearest cent.

Plan 1 Plan 2 Plan 3 10% bonds _ _ $4,350,000 Preferred 5% stock, $80 par _ $4,350,000 2,175,000 Common stock, $8.7 par $8,700,000 4,350,000 2,175,000 Total $ 8,700,000 $ 8,700,000 $ 8,700,000 2.173.500 Required

Explanation / Answer

1 Plan 1 Plan 2 Plan 3 Income before bond interest and income tax 17400000 17400000 17400000 Interest expense 0 0 435000 Income before income tax 17400000 17400000 16965000 Income tax expense 6960000 6960000 6786000 Net income 10440000 10440000 10179000 Less: Preferred dividends 0 217500 108750 Income for common shareholders 10440000 10222500 10070250 Common shares outstanding 1000000 500000 250000 Earnings Per Share on Common Stock 10.44 20.45 40.28 2 Plan 1 Plan 2 Plan 3 Income before bond interest and income tax 8265000 8265000 8265000 Interest expense 0 0 435000 Income before income tax 8265000 8265000 7830000 Income tax expense 3306000 3306000 3132000 Net income 4959000 4959000 4698000 Less: Preferred dividends 0 217500 108750 Income for common shareholders 4959000 4741500 4589250 Common shares outstanding 1000000 500000 250000 Earnings Per Share on Common Stock 4.96 9.48 18.36

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