Effect of Financing on Earnings Per Share Three different pl

Effect of Financing on Earnings Per Share

Three different plans for financing an $8,500,000 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:

Required:

1. Determine the earnings per share of common stock for each plan, assuming that the income before bond interest and income tax is $17,000,000. Enter answers in dollars and cents, rounding to the nearest cent.

2. Determine the earnings per share of common stock for each plan, assuming that the income before bond interest and income tax is $8,075,000. Enter answers in dollars and cents, rounding to the nearest cent.

	Plan 1	Plan 2	Plan 3
10% bonds	_		_		$4,250,000
Preferred 5% stock, $80 par	_		$4,250,000		2,125,000
Common stock, $8.5 par	$8,500,000		4,250,000		2,125,000
	Total	$ 8,500,000		$ 8,500,000		$ 8,500,000

Solution

Plan 1 Plan 2 Plan 3 Income before bond interest and income tax 17000000 17000000 17000000 Less: Interest expense 0 0 425000 Income before income tax 17000000 17000000 16575000 Less: Income tax 6800000 6800000 6630000 Net income 10200000 10200000 9945000 Less: Preferred dividends 0 212500 106250 Net income for common shareholders 10200000 9987500 9838750 Common Shares outstanding 1000000 500000 250000 Earnings Per Share on Common Stock 10.20 19.98 39.36 2 Plan 1 Plan 2 Plan 3 Income before bond interest and income tax 8075000 8075000 8075000 Less: Interest expense 0 0 425000 Income before income tax 8075000 8075000 7650000 Less: Income tax 3230000 3230000 3060000 Net income 4845000 4845000 4590000 Less: Preferred dividends 0 212500 106250 Net income for common shareholders 4845000 4632500 4483750 Common Shares outstanding 1000000 500000 250000 Earnings Per Share on Common Stock 4.85 9.27 17.94