Songbird Airlines is considering these two alternatives for financing the purcha

Question

Songbird Airlines is considering these two alternatives for financing the purchase of a fleet of airplanes.

1. Issue 59,700 shares of common stock at $40 per share. (Cash dividends have not been paid nor is the payment of any contemplated.) 2. Issue 15%, 15-year bonds at face value for $2,388,000. Songbird Airlines is considering these two alternatives for financing the purchase of a fleet of airplanes. It is estimated that the company will earn $826,700 before interest and taxes as a result of this purchase. The company has an estimated tax rate of 40% and has 90,600 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. (Round earnings per share to 2 decimal places, e.g. $2.66.)

Explanation / Answer

Plan 1:

EBIT= 826,700

Interest=0

EBT= 826700

Tax(40%)= 330680

EAT= 496020

no of shares(59,700+90,600)= 150300

EPS= ( 496020/150300)= .33

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