Question

EYK10-3. Business Decision Problem Kingston Corporation has total assets of $5,200,000 and has been earning an average of $800,000 before income taxes the past several years. The firm is planning to expand plant facilities to manufacture a new product and needs an additional $2,000,000 in funds, on which it expects to earn 18 percent before income tax. The income tax rate is expected to be 20 percent for the next several years. The firm has no long-term debt outstanding and presently has 75,000 shares of common stock outstanding. The firm is considering three alternatives: 1. Obtain the $2,000,000 by issuing 25,000 shares of common stock at $80 per share. 2. Obtain the $2,000,000 by issuing $1,000,000 of ten percent, 20-year bonds at face value and 12,500 shares of common stock at $80 per share. 3. Obtain the $2,000,000 by issuing $2,000,000 of ten percent, 20-year bonds at face value. Required As a shareholder of Kingston Corporation, which of the three alternatives would you prefer if your main concern is enhancing the firm's earnings per share? (Hint: Divide net income by the number of outstanding common shares to determine the comnanule narinnahme
the last word says percentage

Answer 1

alternative 1 4 А в с G H alternative 1 existing income before income taxes additional income before income taxes total income before income taxes income taxes expense income after tax number of common share outstanding earnings per share $ 800,000 $ 350,000 $ 1,160,000 $ 232,000 $ 928,000 100,000 $ 9.28 | alternative 2 existing income before income taxes additional income before income taxes interest expense total income before income taxes income taxes expense income after tax number of common share outstanding earnings per share $ 800,000 $360,000 $ 100,000 $ 1,060,000 $ 212,000 $ 848,000 87,500 $9.69 alternative 3 existing income before income taxes additional income before income taxes interest expense total income before income taxes income taxes expense income after tax number of common share outstanding earnings per share $ 800,000 $360,000 $ 200,000 $ 960,000 $ 192,000 $ 768,000 75,000 $ 10.24 decision - reason alternative 3 i.e. issue of $2,000,000 of ten percent, 20-year bond at face value should be preferred. because this alternative is offering highest earnings per share.

for formulas and calculations, refer to the image below -

X fac alternative 1 B C alternative 1 existing income before income taxes additional income before income taxes total income before income taxes income taxes expense income after tax number of common share outstanding earnings per share 800000 =2000000*18% =E2+E3 =E4*20% =E4-E5 =75000+25000 =E6/E7 alternative 2 existing income before income taxes additional income before income taxes interest expense total income before income taxes income taxes expense income after tax number of common share outstanding earnings per share 800000 =2000000*18% =1000000*10% =E10+E11-E12 =E13*20% =E13-E14 =75000+12500 =E15/E16 alternative 3 existing income before income taxes additional income before income taxes interest expense total income before income taxes income taxes expense income after tax number of common share outstanding earnings per share 800000 =2000000*18% =2000000*10% =E19+E20-E21 =E22*20% =E22-E23 =75000 =E24/E25 decision - reason alternative 3 i.e. issue of $2,000,000 of ten percent, 20-year bond at face value should be preferred. because this alternative is offering highest earnings per share.