Question

Smith Co. is considering the following alternative plans for financing the company:

Plan I Plan II

Issue 10% Bonds (at face) - $1,000,000

Issue $10 Common Stock $3,000,000 $2,000,000

Determine the earnings per share of common stock under the two alternative financing plans, assuming income before bond interest and income tax is $1,000,000.

Answer 1

The earnings per share (EPS) of common stock under the two alternative financing plans can be calculated by dividing the income available to common stockholders by the number of common shares outstanding.

Let's calculate the EPS for each plan:

Plan I:
In Plan I, Smith Co. will issue 10% bonds worth $1,000,000. Since the income before bond interest and income tax is $1,000,000, we need to subtract the bond interest from the income available to common stockholders.

Income available to common stockholders = Income before bond interest - Bond interest
Income available to common stockholders = $1,000,000 - ($1,000,000 * 10%)
Income available to common stockholders = $1,000,000 - $100,000
Income available to common stockholders = $900,000