Question

Folmar Co. is considering the following alternative financing plans:

	Plan 1		Plan 2
Issue 10% bonds (at face value)	$960,000		$480,000
Issue preferred $1 stock, $10 par	—		800,000
Issue common stock, $5 par	960,000		640,000

Income tax is estimated at 40% of income.

Determine the earnings per share on common stock, assuming income before bond interest and income tax is $288,000.

Enter answers in dollars and cents, rounding to the nearest cent.

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

Answer 1

SOLUTION

PLAN 1

	Amount ($)
Net Income	288,000
Interest Expense ($960,000*10%)	(96,000)
Earnings before income tax	192,000
Income Tax (40%)	(76,800)
Net Income	115,200

Common shares outstanding = 960,000 / 5 = 192,000

EPS = (Net Income - Preferred Dividends) / Common shares outstanding

= ($115,200 - $0) / 192,000

= $115,200 / 192,000 = $0.60

PLAN -2

	Amount ($)
Net Income	288,000
Interest Expense ($480,000*10%)	(48,000)
Earnings before income tax	240,000
Income Tax (40%)	(96,000)
Net Income	144,000

Common shares outstanding = 640,000 / 5 = 128,000

Preferred dividends = 800,000 / 10 * 1 = $80,000

EPS = (Net Income - Preferred Dividends) / Common shares outstanding

= ($144,000 - $80,000) / 128,000

= $64,000 / 128,000

= $0.5