Question

Alternative Financing Plans

Frey Co. is considering the following alternative financing plans:

	Plan 1		Plan 2
Issue 10% bonds (at face value)	$1,080,000		$540,000
Issue preferred $1 stock, $10 par	—		900,000
Issue common stock, $5 par	1,080,000		720,000

Income tax is estimated at 40% of income.

Determine the earnings per share on common stock, assuming that income before bond interest and income tax is $756,000.

Enter answers in dollars and cents, rounding to two decimal places.

Plan 1	$ _____ Earnings per share on common stock
Plan 2	$ _____ Earnings per share on common stock

Answer 1

Plan 1 $ 1.80 Earnings per share on common stock
Plan 2 $ 2.30 Earnings per share on common stock
Workings:
	Plan 1	Plan 2
Income before bond interest and income tax	756000	756000
Less: Bond interest expense	108000	54000
Income before income tax	648000	702000
Less: Income tax expense 40%	259200	280800
Net income	388800	421200
Less: Preferred Dividends	0	90000
Net income for Common Stockholders	388800	331200
Divide by Common shares outstanding	216000	144000
Earnings per share on common stock	1.80	2.30
Common shares outstanding:
Plan 1 = 1080000/5 = 216000
Plan 2 = 720000/5 = 144000