Question

Effect of Financing on Earnings Per Share

Three different plans for financing an $8,500,000 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:

		Plan 1		Plan 2		Plan 3
10% bonds		_		_		$4,250,000
Preferred 5% stock, $80 par		_		$4,250,000		2,125,000
Common stock, $8.5 par		$8,500,000		4,250,000		2,125,000
	Total	$ 8,500,000		$ 8,500,000		$ 8,500,000

Required:

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

	Earnings Per Share on Common Stock
Plan 1	$
Plan 2	$
Plan 3	$

2. Determine the earnings per share of common stock for each plan, assuming that the income before bond interest and income tax is $8,075,000. Enter answers in dollars and cents, rounding to the nearest cent.

	Earnings Per Share on Common Stock
Plan 1	$
Plan 2	$
Plan 3	$

Answer 1

	Plan 1	Plan 2	Plan 3
Income before bond interest and income tax	17000000	17000000	17000000
Less: Interest expense	0	0	425000
Income before income tax	17000000	17000000	16575000
Less: Income tax	6800000	6800000	6630000
Net income	10200000	10200000	9945000
Less: Preferred dividends	0	212500	106250
Net income for common shareholders	10200000	9987500	9838750
Common Shares outstanding	1000000	500000	250000
Earnings Per Share on Common Stock	10.20	19.98	39.36
2
	Plan 1	Plan 2	Plan 3
Income before bond interest and income tax	8075000	8075000	8075000
Less: Interest expense	0	0	425000
Income before income tax	8075000	8075000	7650000
Less: Income tax	3230000	3230000	3060000
Net income	4845000	4845000	4590000
Less: Preferred dividends	0	212500	106250
Net income for common shareholders	4845000	4632500	4483750
Common Shares outstanding	1000000	500000	250000
Earnings Per Share on Common Stock	4.85	9.27	17.94