Question

Effect of Financing on Earnings Per Share

Three different plans for financing a $5,100,000 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		_		_		$2,550,000
Preferred 5% stock, $80 par		_		$2,550,000		1,275,000
Common stock, $5.1 par		$5,100,000		2,550,000		1,275,000
	Total	$ 5,100,000		$ 5,100,000		$ 5,100,000

Required:

1. Determine for each plan the earnings per share of common stock, assuming that the income before bond interest and income tax is $10,200,000. 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 for each plan the earnings per share of common stock, assuming that the income before bond interest and income tax is $4,845,000. Enter answers in dollars and cents, rounding to the nearest cent.

	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.

Answer 1

1) Calculate earning per share of Common Stock

	plan 1	Plan 2	Plan 3
Earning before interest and taxes	10200000	10200000	10200000
Less: Interest expense			-255000
Income before tax	10200000	10200000	9945000
Less: Income tax	-4080000	-4080000	-3978000
Net income	6120000	6120000	5967000
Less: Preferred Dividend		-127500	-63750
Income for Common stockholders	6120000	5992500	5903250
Share outstanding	1000000	500000	250000
EPS	6.12	11.99	23.61

2) Calculate earning per share of Common Stock

	plan 1	Plan 2	Plan 3
Earning before interest and taxes	4845000	4845000	4845000
Less: Interest expense			-255000
Income before tax	4845000	4845000	4590000
Less: Income tax	1938000	1938000	1836000
Net income	2907000	2907000	2754000
Less: Preferred Dividend		-127500	-63750
Income for Common stockholders	2907000	2779500	2690250
Share outstanding	1000000	500000	250000
EPS	2.91	5.56	10.76

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.