Question

Question 1 View Policies Current Attempt in Progress Swifty Airlines is considering two alternatives for the financing of a purchase of a fleet of airplanes. These two alternatives are: 1. Issue 103,500 shares of common stock at $30 per share. (Cash dividends have not been paid nor is the payment of any contemplated.) 2. Issue 7%, 10-year bonds at face value for $3,105,000. It is estimated that the company will earn $720,000 before interest and taxes as a result of this purchase. The company has an estimated tax rate of 30% and has 117,000 shares of common stock outstanding prior to the new financing. Determine the effect on net income and earnings per share for these two methods of financing. (Round earnings per share to 2 decimal places, e.g. 2.25.) Plan One Issue Stock Plan Two Issue Bonds Net income Earnings per share $

Answer 1

Plan one

Issue Stock

Earning Before Interest and Tax	$720,000
(-) Tax (@30%)	$216,000
Net Income	$504,000
Earning Per Share =Net Income/No. Of Shares (No. of shares = 117,000 + 103,500 =220,500)	504000 20500
Earning Per Share	$2.28

Plan Two

Issue Bonds

Earning Before Interest and Tax	$720,000
(-) Interest ($3,105,000 × 7%)	$217350
Earning After Interest Before Tax	$502,650
(-) Tax (@30%)	$150,795
Net Income	$351,855
Earning Per Share = Net Income /No. Of Shares No. Of Shares = 117,000	351855 117000
Earning Per Share	$3.00

So,

	Plan One Issue Stock	Plan Two Issue Bonds
Net Income	$504,000	$351,855
Earning Per Share	$2.28	$3.00