Question

Effect of Financing on Earnings Per Share Three different plans for financing an $7,700,000 corporation are under consideration by its organizers. Under each of the following plans, the securities will be issued at their par or face amount, and the income tax rate is estimated at 40% of income: Plan 1 Plan 2 Plan 3 10% Bonds $3,850,000 Preferred 5% stock, $80 per $3,850,000 1,925,000 Common stock, $7.7 par $7,700,000 3,850,000 1,925,000 Total 5 7,700,000 $ 7,700,000 $ 7,700,000 Required: 1. Determine the earnings per share of common stock for each plan, assuming that the income before bond interest and income tax is $15,400,000. Enter answers in dollars and cents, rounding to two deci- mal places. Earnings Per Share on Common Stock Plan 1 Plan 2 Plan 3 2. Determine the earnings per share of common stock for each plan, assuming that the income before bond interest and income tax is

Answer 1

1. Determine the earnings per share of common stock for each plan, assuming that the income before bond interest and income tax is $15,400,000. (Enter answers in dollars and cents, rounding to the nearest whole cent.)
	Plan 1	Plan 2	Plan 3
Income before bond interest and income tax	$              15,400,000.00	$     15,400,000.00	$                   15,400,000.00
Less : Interest Exp	$                                  -	$                        -	$                        385,000.00
EBT	$              15,400,000.00	$     15,400,000.00	$                   15,015,000.00
Less: Tax @40%	$                6,160,000.00	$       6,160,000.00	$                     6,006,000.00
Net Income	$                9,240,000.00	$       9,240,000.00	$                     9,009,000.00
Less: Preferred Dividend		$          192,500.00	$                          96,250.00
Net Income available for common stockholder (A)	$                9,240,000.00	$       9,047,500.00	$                     8,912,750.00
# Outstanding Shares (B)	$                1,000,000.00	$          500,000.00	$                        250,000.00
EPS = A/B	$                              9.24	$                   18.10	$                                 35.65
	Earnings Per Share on Common Stock
Plan 1	$                              9.24
Plan 2	$                            18.10
Plan 3	$                            35.65
2. Determine the earnings per share of common stock for each plan, assuming that the income before bond interest and income tax is $7,315,000. (Enter answers in dollars and cents, rounding to the nearest whole cent.)
	Plan 1	Plan 2	Plan 3
Income before bond interest and income tax	$                7,315,000.00	$       7,315,000.00	$                     7,315,000.00
Less : Interest Exp	$                                  -	$                        -	$                        385,000.00
EBT	$                7,315,000.00	$       7,315,000.00	$                     6,930,000.00
Less: Tax @40%	$                2,926,000.00	$       2,926,000.00	$                     2,772,000.00
Net Income	$                4,389,000.00	$       4,389,000.00	$                     4,158,000.00
Less: Preferred Dividend		$          192,500.00	$                          96,250.00
Net Income available for common stockholder (A)	$                4,389,000.00	$       4,196,500.00	$                     4,061,750.00
# Outstanding Shares (B)	$                1,000,000.00	$          500,000.00	$                        250,000.00
EPS = A/B	$                              4.39	$                     8.39	$                                 16.25
	Earnings Per Share on Common Stock
Plan 1	$                              4.39
Plan 2	$                              8.39
Plan 3	$                            16.25
3. The principal advantaged  of Plan 1 is that it involves only the issuance of common stock, which does not require a periodic interest payment or return of principal, and a payment of preferred dividends Select (is or is not) required.

A B с D 9 1. Determine the earnings per share of common stock for each plan, assumi 10 Plan 1 Plan 2 Plan 3 15400000 0 11 Income before bond interest and income tax 12 Less : Interest Exp 13 EBT 14 Less: Tax @40% 15 Net Income 16 Less: Preferred Dividend 15400000 0 =B11-B12 =B11*40% =B13-B14 =C11-C12 =C11-40% =C13-C14 =C55% 15400000 =D4 10% =D11-012 =D1340% =D13-D14 =D55% =C15-C16 =C6/7.7 =C17/C18 =D15-016 =D6/7.7 =D17/D18 17 Net Income available for common stockholder (A) =B15-B16 18 #Outstanding Shares (B) =B6/7.7 19 EPS = A/B =B17/B18 20 21 Earnings Per Share on Common Stock 22 Plan 1 =B19 23 Plan 2 =C19 24 Plan 3 =D19 25 2. Determine the earnings per share of common stock for each plan, assumi 26 27 Plan 1 Plan 2 Plan 3 7315000 0 28 Income before bond interest and income tax 29 Less : Interest Exp 30 ЕВТ 31 Less: Tax @40% 32 Net Income 33 Less: Preferred Dividend =B28-B29 =B28*40% =B30-B31 7315000 0 =C28-C29 =C28*40% =C30-C31 =C16 7315000 =D12 =D28-D29 =D30*40% =D30-D31 =D16 =B32-B33 =B18 =B34/B35 =C32-C33 =C18 =C34/C35 =D32-D33 =D18 =D34/D35 34 Net Income available for common stockholder (A) 35 # Outstanding Shares (B) 36 EPS = A/B 37 38 39 Plan 1 40 Plan 2 41 Plan 3 42 Earnings Per Share on Common Stock =B36 =C36 =D36

Answer 2

SOLUTION :

Q1 :

PLAN 1 :

EBIT = 15400000 ($)

EBT = 15400000 - 0 = 15400000 ($)

EAT = 15400000(1 - 0.40) = 9240000 ($)

EPS  post PS dividend = 9240000/(7700000/7.7) = 9.24 ($) (ANSWER).

PLAN 2 :

EBIT = 15400000 ($)

EBT = 15400000 - 0 = 15400000 ($)

EAT = 15400000(1 - 0.40) = 9240000 ($)

EPS  post PS dividend = (9240000 - 3850000*0.05)/(3850000/7.7) = 18.095 = 18.10 ($) (ANSWER).

PLAN 3 :

EBIT = 15400000 ($)

EBT = 15400000 - 3850000*0.10 = 15015000 ($)

EAT = 15015000(1 - 0.40) = 9009000 ($)

EPS  post PS dividend = (9009000 - 1925000*0.05)/(1925000/7.7) = 35.65 ($) (ANSWER).

Q2 :

PLAN 1 :

EBIT = 7315000 ($)

EBT = 7315000 - 0 = 7315000 ($)

EAT = 7315000(1 - 0.40) = 4389000 ($)

EPS  ex-PS dividend = 4389000/(7700000/7.7) = 4.39 ($) (ANSWER).

PLAN 2 :

EBIT = 7315000 ($)

EBT = 7315000 - 0 = 7315000 ($)

EAT = 7315000(1 - 0.40) = 4389000 ($)

EPS  ex-PS dividend = (4389000 - 3850000*0.05)/(3850000/7.7) = 8.39 ($) (ANSWER).

PLAN 3 :

EBIT = 7315000 ($)

EBT = 7315000 - 3850000*0.10 = 6930000 ($)

EAT = 6930000(1 - 0.40) = 4158000 ($)

EPS  ex-PS dividend = (4158000 - 1925000*0.05)/(1925000/7.7) = 16.25 ($) (ANSWER).