Question

Alternative Financing Plans Frey Co. is considering the following alternative financing plans: Plan 1 Plan 2 Issue 10% bonds (at face value) $1,440,000 $720,000 Issue preferred $1 stock, $10 par — 1,200,000 Issue common stock, $5 par 1,440,000 960,000 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 $1,008,000. 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

Answer:

 1st Plan Earning per Share $  1.80

2nd Plan Earning per Share $ 2.30

The Second Plan provides better earnings per share.

Explanation:

1st Plan:

Income before Interest and taxes 1,008,000

Bonds Payable Interest:                   (144,000)  

Income before taxes                        864,000

Income tax expense                       (345,600)  

Net Income                                        518,400

Quantity of Common Stock:

$ 1,440,000 / $5 = 288,000

Earing per share:

518,400 / 288,000 = $1.80

2nd Plan:

Income before Interest and taxes 1,008,000

Bonds Payable Interest:                    (72,000)  

Income before taxes                        936,000

Income tax expense                       (374,400)  

Net Income                                        561,600

Preferred Shares Dividends            (120,000)

Available for common stock            441,600

Quantity of preferred Stock:

$1,200,000 / $10 =120,000 shares

Dividends on Preferred Shares:

120,000 x $1 = 120,000

Quantity of Common Stock:

$ 960,000 / $5 = 192,000

Earing per share:

441,600 / 192,000 = $2.30