Beech and co, Inc. has three different plans for financing $4,000,000 expansion

Question

Beech and co, Inc. has three different plans for financing $4,000,000 expansion project which are currently under consideration.

Plan 1: is financing the entire project by the issuance of common stock,$10 par.

plan2: is financing half of the project by common stock, $10 par and other half by using 9% preferred stock.

plan 3: calls for issuance of 12% bond for $2,000,000 with the remaining capitalization split between the 9% preferred stock and the common stock $10 par

the board of directors estimate that the project will earn $1,000,000 annually, before deducting interest on the bonds and income tax is estimated at 30% of income.

(a) compute the earnings par share on common stock

(b) which is the cheapest means of financing the project? why?

Explanation / Answer

Answer (a)

Answer (b)

cheapest means of financing the project is to issue common stock because it involves no fixed interest/ dividend cost

Particulars Plan1 Plan 2 Plan 3 Common Stock 4000000 2000000 1000000 9% Preferred Stock 0 2000000 1000000 12% Bond 0 0 2000000 No of Equity Shares 400000 200000 100000 EBIT 1000000 1000000 1000000 Less: Interest 0;0; 2000000*12% 0 0 240000 EBT 1000000 1000000 760000 Tax @ 30% 300000 300000 228000 Earning After Tax 700000 700000 532000 Less: Preference Dividend: 0;2000000*9%,1000000*9% 0 180000 90000 Earning for Equity share holder (A) 700000 520000 442000 No of Equity Shares (B) 400000 200000 100000 Earning per share(A/B) 1.75 2.6 4.42

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