Question

Alternative Financing Plans Frey Co. is considering the following alternative financing plans: Plan 1 Plan 2 Issue 5% bonds (at face value) $6,000,000 $2,000,000 Issue preferred $1 stock, $20 par — 6,000,000 Issue common stock, $25 par 6,000,000 4,000,000 Income tax is estimated at 40% of income. Determine the earnings per share of common stock, assuming income before bond interest and income tax is $800,000. Enter answers in dollars and cents, rounding to the nearest whole cent. Plan 1 $ Earnings per share on common stock Plan 2 $ Earnings per share on common stock

Answer 1

Answer:

Plan 1 = $1.25

Plan 2 = $0.75

Explanation:

Particulars                              Plan 1                                  Plan 2

5% Bonds                          $6,000,000                        $2,000,000

Pref Stock $20 par                                                       $6,000,000

Equity $25 par                 $6,000,000                      $4,000,000

Provided earnings before bond interest and income tax = $800,000

Earnings                         $800,0000                            $800,000

Less:Bond interest @5% ($300,000)                            ($100,000)

Earnings after bond interest  500,000                          $700,000

Less: Taxes @40%         ($200,000)                            ($280,000)

Earnings after Taxes      $300,000                               $420,000

Less: Pref dividend Assumed rate @5%

                                            NIL                                     ($300,000)

Earnings for equity          $300,000                               $120,000

Number of shares             240,000                                  160,000

Earnings Per Share         $1.25                                         $0.75

Number of shares = $6,000,000/25 = 240,000 Plan 1

Number of shares = $4,000,000/25 = 160,000 Plan 2

Plan 1 = $1.25

Plan 2 = $0.75