Question

AMC Corporation has the financing options below. Assume all bonds and stock areissued at their par or face amount. The company’s earnings before interest and income taxes for the year are $1,500,000 at a 40% tax rate. Which option would generate the highest earnings per share?

Issue 18% bonds	Option 1 Amount $1,000,000	Percent 20%	Option 2 Amount $3,000,000	Percent 60%
Issue preferred 4% stock, $15 par value	2,500,000	50	1,000,000	20
Issue common stock, $5 par value	1,500,000	30	1,000,000	20
	$5,000,000	100%	$5,000,000	100%

Answer 1

option 2 would generate highest EPS of $ 2.68

	Option 1	option 2
Earnings before income and taxes	$1,500,000	$1,500,000
Interest expense@18%	$ 180,000	$ 540,000
Earnings before tax	$1,320,000	$ 960,000
Tax@40%	$ 528,000	$ 384,000
Net income	$792,000	$ 576,000
Preferred dividend@4%	$ 100,000	$ 40,000
Earnings available to equity share holders (I)	$ 692,000	$536,000
Shares outstanding (II)	300,000	200,000
Earnings per share (I / II)	2.31	2.68