Question

Alternative Financing Plans

Frey Co. is considering the following alternative financing plans:

	Plan 1		Plan 2
Issue 10% bonds (at face value)	$1,320,000		$660,000
Issue preferred $1 stock, $10 par	—		1,100,000
Issue common stock, $5 par	1,320,000		880,000

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 $1,056,000.

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:-

Earnings per share on common stock for plan 1 :-

	Calculations	Amount
Earnings before bond interest and income tax		$1,056,000
Bond interest	= $1,320,000 * 10% = $1,32,000	$1,32,000
Net income before taxes	= $1,056,000 - $1,32,000 = $924,000	$924,000
Income tax	= $924,000 * 40% = $369,600	$369,600
Net income	=924,000 - 369,600 = $554,400	$554,400

Number of common stock = $1,320,000 / $5

= $264,000

Number of common stock = $264,000

Earning per Share = net income / number of common stock

= $554,400 / $264,000

= $2.1

Earning per Share = $2.1

Earnings per share on common stock for plan 2 :-

	Calculations	Amount
Earnings before bond interest and income tax		$1,056,000
Bond interest	= $660,000 * 10% = $66,000	$66,000
Net income before taxes	= $1,056,000 - $66,000 = $990,000	$990,000
Income tax	= $990,000 * 40% = $396,000	$396,000
Net income	= $990,000 - $396,000 = $594,000	$594,000
Preference dividend	$1,100,000 / 10 = $1,10,000	$1,10,000
Net income after preference dividend	= $594,000 - $1,10,000 = $484,000	$484,000

Number of common stock = $880,000 / $5

= $176,000

Number of common stock =  $176,000

Earning per share = $484,000 / $176,000

= $2.75

Earning per share = $2.75

Plan 1	Earnings per share on common stock is $2.1
Plan 2	Earnings per share on common stock is $2.75