Brief Exercise 11-11 Splish Brothers Inc.currently has 670,000 shares of common

Question

Brief Exercise 11-11

Splish Brothers Inc.currently has 670,000 shares of common stock outstanding. Splish Brothers Inc. is considering these two alternatives to finance its construction of a new $1.45 million plant:

Issuance of 145,000 shares of common stock at the market price of $10 per share.

Issuance of $1.45 million, 6% bonds at face value.

Complete the table. (Round earnings per share to 2 decimal places, e.g. $2.66.) Issue Stock Issue Bonds Income before interest and taxes Interest expense from bonds Income before income taxes $1,570,000 $1,570,000 Income tax expense (35%) Net income Outstanding shares 670,000 Earnings per share Indicate which alternative is preferable. is preferable.

Explanation / Answer

Issuance of bonds is preferable because EPS is higher if we issue the bonds.

Issue Stock Issue Bonds Income before interest and taxes $1,570,000 $1,570,000 Interest expense from bonds
($1,450,000 x 6%) $87,000 Income before income taxes $1,570,000 $1,483,000 Income taxes expense (35%) $549,500 $519,050 Net Income $1,020500 $963,950 Outstanding Shares (670,000 + 145,000) 815,000 670,000 Earnings per share $1.25 $1.44

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