Question

Pharoah Airlines is considering two alternatives for the financing of a purchase of a fleet of airplanes. These two alternatives are: 1. Issue 84,900 shares of common stock at $30 per share. (Cash dividends have not been paid nor is the payment of any contemplated.) 2. Issue 9%, 10-year bonds at face value for $2,547,000. It is estimated that the company will earn $780,000 before interest and taxes as a result of this purchase. The company has an estimated tax rate of 40% and has 108,500 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.)

Answer 1

Answer
	Alternative-1	Alternative-2
Income before interest and taxes	$           780,000	$                    780,000
Less: Interest	$                     -	$                    229,230
Income before tax	$           780,000	$                    550,770
Less: Income tax @40%	$           312,000	$                    220,308
Net income	$           468,000	$                    330,462
Share outstanding	$           193,400	$                    108,500
EPS	2.42	3.05