Question

Alternative Financing Plans

Frey Co. is considering the following alternative financing plans:

	Plan 1		Plan 2
Issue 10% bonds (at face value)	$1,120,000		$560,000
Issue preferred $1 stock, $10 par	—		930,000
Issue common stock, $5 par	1,120,000		750,000

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 $336,000.

Enter answers in dollars and cents, rounding to two decimal places.

Plan 1	$ Earnings per share on common stock
Plan 2	$ Earnings per share on common stock

Answer 1

Plan 1:

Net income = EBIT - interest - taxes

= $336000 - ($1120000 x 10%) - {$336000 - ($1120000 x 10%)} x 40%

= $134400

Earning per share = (net income - preferred dividends)/average number of common stock outstanding

= ($134400 - $0)/($1120000/$5)

= $0.6 per share

Plan 2:

Net income = EBIT - interest - taxes

= $336000 - ($560000 x 10%) - {$336000 - ($560000 x 10%)} x 40%

= $168000

preferred dividends = ($930000/$10) x $1 = $93000

Earning per share = (net income - preferred dividends)/average number of common stock outstanding

= ($168000 - $93000)/($750000/$5)

= $0.5 per share