Question

Alternative Financing Plans

Owen Co. is considering the following alternative financing plans:
Plan 1 Plan 2
Issue 7% bonds (at face value) $5,000,000 $3,400,000
Issue preferred $1 stock, $20 par — 3,600,000
Issue common stock, $25 par 5,000,000 3,000,000
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 $750,000.
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

Owen Co.

Alternative Financing Plans

Plan 1 Plan 2

Earnings per share $1.20 $1.06

Step-by-step explanation:

a) Data and Calculations:

Plan 1 Plan 2

Issue 7% bonds (at face value) $5,000,000 $3,400,000

Issue preferred $1 stock, $20 par — 3,600,000

Issue common stock, $25 par 5,000,000 3,000,000

Income tax is estimated at 40% of income.

EBIT = $750,000 $750,000

Interest on bonds 350,000 238,000

Income before taxes $400,000 $512,000

Income tax 160,000 204,800

Net income $240,000 $307,200

Preferred dividend - $180,000

Earnings available to common

stockholders $240,000 $127,200

Outstanding shares 200,000 120,000

Earnings per share $1.20 $1.06

$1.20 ($240,000/200,000) $1.06 ($127,200/120,000)

Preferred stock dividend rate = 5% ($1/$20 * 100)

Preferred stock dividend = $180,000 ($3,600,000/$20 * $1)

or 5% of $3,600,000