Question

Frey Co. is considering the following alternative financing plans: Plan 1 Plan 2 Issue 10% bonds (at face value) $2,000,000 $1,000,000 Issue preferred $1 stock, $10 par — 1,660,000 Issue common stock, $5 par 2,000,000 1,340,000 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 $600,000.

Answer 1

	Plan 1	Plan 2
Earnings Before bond interest and income tax	600000	600000
Bond interest expense	200000	100000
Earnings before income tax	400000	500000
Income tax @ 40%	160000	200000
Net income	240000	300000
Dividends on preferred stock	0	166000
Earnings available for common stock	240000	134000
Number of common shares	400000	268000
Earnings per share	0.60	0.50
Workings:
Income tax:
Plan 1 = 400000*40% = $160000
Plan 2 = 500000*40% = $200000
Dividends on preferred stock = (1660000/10)*1=$166000
Number of common shares:
Plan 1 = 2000000/5 = 400000
Plan 2 = 1340000/5 = 268000