Question

Sage Hill Inc. currently has 750,000 shares of common stock outstanding. Sage Hill Inc. is considering these two alternatives to finance its construction of a new $1.85 milion plant: 1. Issuance of 185,000 shares of common stock at the market price of $10 per share. 2. Issuance of $1.85 million, 8% 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 $1,650,000 $1,650,000 Interest expense from bonds enter a dollar amount enter a dollar amount Income before income taxes enter a subtotal of the two previous amounts enter a subtotal of the two previous amounts Income tax expense (30%) enter a dollar amount enter a dollar amount Net income $enter a total net income $enter a total net income Outstanding shares enter a number of shares 750,000 Earnings per share $enter earnings per share rounded to 2 decimal places $enter earnings per share rounded to 2 decimal places

Indicate which alternative is preferable. select between 2 options

is preferable.

Answer 1

Ans.

	Issue stock	Issue bond
Income before interest and taxes	$1,650,000.00	$1,650,000.00
Interest expense	$                  -	$   148,000.00
Income before tax	$1,650,000.00	$1,502,000.00
Income tax expense (30%)	$   495,000.00	$   450,600.00
Net income	$1,155,000.00	$1,051,400.00
Outstanding shares	935,000.00	750,000.00
Earning per share	$1.24	$1.40

Alternative 2 is preferrable as the Earning per share is higher than alternative 1. Even though the net income is higher when stock is issued but the main objective of financial management is to maximize the share holder's wealth.

So wealth maximization is considered as the objective of Financial Management rather than profit maximization therefore, Sage Hill Inc. should opt to issue Bonds.