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Effect of Financing on Earnings Per Share Three different plans for financing an $7,000,000 corporation are...

  1. Effect of Financing on Earnings Per Share

    Three different plans for financing an $7,000,000 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 _ _ $3,500,000
    Preferred 5% stock, $80 par _ $3,500,000 1,750,000
    Common stock, $7 par $7,000,000 3,500,000 1,750,000
    Total $ 7,000,000 $ 7,000,000 $ 7,000,000

    Required:

    1. Determine the earnings per share of common stock for each plan, assuming that the income before bond interest and income tax is $14,000,000. Enter answers in dollars and cents, rounding to two decimal places.

    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 $6,650,000. Enter answers in dollars and cents, rounding to two decimal places.

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

    3. The principal   of Plan 1 is that it involves only the issuance of common stock, which does not require a periodic interest payment or return of principal, and a payment of preferred dividends required.

Solutions

Expert Solution

1.

Particulars Plan 1 Plan 2 Plan 3
EBIT $        14,000,000 $        14,000,000 $        14,000,000
Less: Interest $              350,000
EBT (EBIT - Interest) $        14,000,000 $        14,000,000 $        13,650,000
Less: Taxes (40%) $          5,600,000 $          5,600,000 $          5,460,000
Net Income $          8,400,000 $          8,400,000 $          8,190,000
Less: Preferred Dividends 0 $              175,000 $                87,500
Earnings for Common Stock (Net Income - Pref Dividend) $          8,400,000 $          8,225,000 $          8,102,500
Number of Shares (Common Stock /$7)            1,000,000               500,000               250,000
EPS (Earnings/ Common Stock) $                     8.40 $                   16.45 $                  32.41

2.

Particulars Plan 1 Plan 2 Plan 3
EBIT $          6,650,000 $          6,650,000 $          6,650,000
Less: Interest $              350,000
EBT (EBIT - Interest) $          6,650,000 $          6,650,000 $          6,300,000
Less: Taxes (40%) $          2,660,000 $          2,660,000 $          2,520,000
Net Income $          3,990,000 $          3,990,000 $          3,780,000
Less: Preferred Dividends 0 $              175,000 $                87,500
Earnings for Common Stock (Net Income - Pref Dividend) $          3,990,000 $          3,815,000 $          3,692,500
Number of Shares (Common Stock /$7)            1,000,000               500,000               250,000
EPS (Earnings/ Common Stock) $3.99 $7.63 $14.77

3.


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