Question

Evaluate Alternative Financing Plans

Domanico Co., which produces and sells biking equipment, is financed as follows:

Bonds payable, 6% (issued at face amount) $5,000,000
Preferred $2.00 stock, $100 par 5,000,000
Common stock, $25 par 5,000,000
Income tax is estimated at 40% of income.

What factors other than earnings per share should be considered in evaluating alternative financing plans?

a.Bonds represent a fixed annual interest requirement, while dividends on stock do not.

b.Dividends reduce retained earnings.

c.Bond holders exercise control over board of directors decisions.

d.Stock must be paid annual dividends.

e.Net income is reduced by dividend expense.

Answer 1

What factors other than earnings per share should be considered in evaluating alternative financing plans?

• b.Dividends reduce retained earnings.

Step-by-step explanation:

Only option B is true, since retained earnings = previous balance + net income - dividends.

• Option A is wrong because preferred stocks collect annual interests or preferred dividends.
• Option C is wrong because common stockholders exercise control over the board of directors.
• Option D is wrong because it is not necessary to pay dividends to common stockholders.
• Option E is wrong because dividend expense reduces retained earnings, not net income.