Question

Exercise 10-17

Skysong Airlines is considering two alternatives for the financing of a purchase of a fleet of airplanes. These two alternatives are:

1.		Issue 109,500 shares of common stock at $30 per share. (Cash dividends have not been paid nor is the payment of any contemplated.)
2.		Issue 9%, 10-year bonds at face value for $3,285,000.

It is estimated that the company will earn $755,000 before interest and taxes as a result of this purchase. The company has an estimated tax rate of 30% and has 111,000 shares of common stock outstanding prior to the new financing.

Determine the effect on net income and earnings per share for these two methods of financing. (Round earnings per share to 2 decimal places, e.g. 2.25.)

		Plan One Issue Stock		Plan Two Issue Bonds
Net income		$		$
Earnings per share		$		$

Answer 1

	Issue stock	Issue Bond
Net Income	$ 528500	$ 321545
Earning per Share	$ 2.39 / Share	$ 2.89 / Share

Working Notes

1) Issue Stock

Income Before Interest and Tax = $755,000

Tax amount = $755,000 * 30% = $226500

A) Net Income = 755000 - 226500 = $ 528500

B) EPS = Net Income / No of Share outstanding

No of Share outstanding = 111000(existing share) + 109500 (new share ) = 220500

EPS = 528500 / 220500 = $ 2.39 per share

* Here No interest expense because financing made through issue of shares

2) Issue Bond

Income Before Interest and Tax = $755,000

Interest = 3,285,000 * 9% = 295650

Net Income = (755000-295650) * 70% = 321545

EPS = 321545 / 111000 = $ 2.89

* Here only 111000 shares outstanding.