Question

Wildhorse Inc. is considering two alternatives to finance its construction of a new $1.90 million plant.

(a)		Issuance of 190,000 shares of common stock at the market price of $10 per share.
(b)		Issuance of $1,900,000, 8% bonds at face value.

Complete the following table. (Round earnings per share to 2 decimal places, e.g. 0.25.)

		Issue Stock		Issue Bond
Income before interest and taxes		$650,000		$650,000
Interest expense
Income before income taxes
Income tax expense (40%)
Net income		$		$
Outstanding shares				460,000
Earnings per share		$		$

Indicate which alternative is preferable.

Net income is

higherlower

if stock is used. However, earnings per share is

lowerhigher

than earnings per share if bonds are used because of the additional shares of stock that are outstanding.

Answer 1

Interest expense = 1,900,000 x 8%

= $152,000

Total outstanding shares in alternative (a) = 460,000+190,000

= 650,000

	Issue Stock	Issue Bond
Income before interest and taxes	$650,000	$650,000
Interest expense	0	-152,000
Income before income taxes	$650,000	$498,000
Income tax expense (40%)	-260,000	-199,200
Net income	390,000	298,800
Outstanding shares	650,000	460,000
Earnings per share	$0.60	$0.65

Net income is higher if stocks is issued. However earning per share is lower than earnings per share if bonds are used

because of the additional shares of stock that are outstanding.

Kindly comment if you need further assistance.

Thanks‼!