Question

Question 5

Alliance Agreement Corporation is considering two plans for raising $2,500,000 to expand its current operations. The first plan involves the sale of $2,500,000, 8%, 10-year bonds sold at face value. The second plan involves selling 50,000 common shares at $50 each. Alliance Agreement Corporation currently has outstanding 200,000 shares of stock and net income of $900,000. Either plan is expected to generate additional income of $400,000 before interest and taxes. The income tax rate is 30%.

1.    Calculate earnings per share for both plans.

Answer 1

Calaculation of Earnings per share(E.P.S) for both plans:

Particulars	Plan I	Plan II
8%, 10 year bonds	$2500000
Common shares (50000×$50)		$2500000
Net income	$900000	$900000
Add: Additional Net income(note1)	$140000	$280000
Total Net income (a)	$1040000	$1180000
No. of common shares (b)	200000 shares	250000 shares
Earnings per share (a/b)	$5.2 per share	$4.72 per share

Notes:

1. Additional Net income:

.	Plan I (8% bonds)	Plan II (common shares)
Income before interest and taxes	$400000	$400000
Less: interest expense($2500000×8%)	($200000)	-
Income before tax	$200000	$400000
Less: income tax @ 30%	$60000 ($200000×30%)	$120000 ($400000×30%)
Net income	$140000	$280000

2. No. Of common shares:

Existing common shares = 200000 shares

For plan I, There is no additional common shares. So total no. of common shares is 200000 shares.

For plan II, 50000 additional common shares issued. So total no. of common shares is 250000 shares.

_____×_____

Let me know if you have any queries, Happy to assit you.

Kindly upvote, All the best,

Keep Learning