Quantitative Reasoning Problem 3 ACC 122 Assignment is to be completed as a Word Document, PDF,...

Quantitative Reasoning Problem 3

ACC 122

Assignment is to be completed as a Word Document, PDF, or on notebook paper and submitted through Moodle

Compare two alternatives for financing - Issuance of common stock vs. Issuance of bonds.

Northeast Airlines is considering two alternatives for the financing of the purchase of a fleet of airplanes. These two alternatives are:

Issue 60000 shares of common stock at $45 per share. (Cash dividends have not been paid nor is the payment of any contemplated).

2. Issue 10%, 10-year bonds at face value for $2,700,000.

It is estimated that the company will earn $800,000 before interest and taxes as a result of this purchase. The company has an estimated tax rate of 30% and has 90000 shares of common stock outstanding prior to the new financing.

Instructions:

How much capital is Northeast Airlines considering raising?

Determine the effect on net income and earnings per share for both of these methods of financing.

Which alternative would you recommend?

Why?

Show calculations as well as explain in words your thinking behind your calculations and conclusions.

Expert Solution

Q1	How much capital is Northeast Airlines considering raising?
Ans	$2,700,000 or 60000 shares x $45

Q2	Determine the effect on net income and earnings per share for both of these methods of financing.
Ans		Plan One	Plan Two
		Issue Stock	Issue Bonds

	Income before interest and taxes	$ 800,000	$ 800,000
	Interest ($2,700,000 X 10%)	-	270,000
	Income before taxes	800,000	530,000
	Income tax expense (30%)	240,000	159,000
	Net income	560,000	371,000
	Outstanding shares	150,000	90,000
	Earnings per share	$ 3.73	$ 4.12

Q3	Which alternative would you recommend?
	Why?
Ans	We will recommend Plan two of bond financing, since it will increase Earning per share.

ekkarill92 answered 2 years ago

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