Question

Frey Co. is considering the following alternative financing plans: Plan 1 Plan 2 Issue 10% bonds (at face value) $1,800,000 $900,000 Issue preferred $1 stock, $10 par — 1,490,000 Issue common stock, $5 par 1,800,000 1,210,000 Income tax is estimated at 40% of income. Determine the earnings per share on common stock, assuming that income before bond interest and income tax is $540,000. Enter answers in dollars and cents, rounding to the nearest cent. Plan 1 $ Earnings per share on common stock Plan 2 $ Earnings per share on common stock

Answer 1

Solution:

Capital Structure
	Plan 1	Plan 2
Issue 10% bonds (at face value)	$1,800,000	$900,000
Issue Preferred $1 stock, $10 par	0	$1,490,000
Issue Common Stock $5 Par	$1,800,000	$1,210,000
Total	$3,600,000	$3,600,000
Calculation of EPS
Income before interest and taxes	$540,000	$540,000
Less: Interest on Bonds
Plan 1 = 1,800,000*10%	$180,000
Plan 2 = $900,000*10%		$90,000
Income before tax	$360,000	$450,000
Less: Taxes @ 40%	$144,000	$180,000
Income After Tax	$216,000	$270,000
Less: Preferred Dividend (number of preferred shares 149,000 * $1)	$0	$149,000
Income Available to Common Stockholders'	$216,000	$121,000
Divide by Number of Common Shares
Plan 1 = $1,800,000 / 5	360000
Plan 2 = 1,210,000 / 5		242000
Earnings Per Share	$0.60	$0.50

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