Question

The Pipen Company wants to expand and is considering options for raising additional cash.  The company estimates net income before the expansion of $250,000 in 2019 and that the expansion will provide additional operating income of $75,000 in 2019.

            Plan 1:  Issue 10,000 additional shares of common stock for $20 per share

            Plan 2:  Issue $200,000 in 20-year, 12% bonds payable.

a. Compare these option, assuming a 30% income tax rate:

b. Which option will contribute more net income in 2019?  Which option provides the highest EPS?

Answer 1

Particular	Plan-1	Plan-2
Earnings before interest and tax	75,000	75,000
less: Interest	-	24,000 (200,000 x 12%)
Earning before tax	75,000	51,000
Less: tax (30%)	22,500.00	15,300
profit after tax	52,500	35,700
less: preferred dividend	-	-
net income	52,500	35,700

Plan-1 contribute will contribute more net income in 2019

Plan-2 provides highest EPS on the assumption that due to plan 2 there will be no increase in existing common share while net income will increase by 35,700 hence EPS will increase.