Question

Problem 5 (10 рoints) At the beginning of this year, Allen, the main shareholder of the Allen Corporation, is considering expanding his business using two financing plans. Plan 1 is to borrow $50,000 with annual interest of 5%, and Plan 2 is to issue 50,000 shares at $1 per share. Before any new financing, the company has a $300,000 net income and 100,000 shares outstanding at $1 per share. The expansion can create additional income of $100,000 before interest and taxes. The income tax rate is 35%. |Required: Analyze Allen Corporation's situation to determine which plan leads to higher earnings per share 1 PLAN 1 PLAN 2 Net income before expansion.... Project income before interest and income tax. Less interest expense ()..... Project income before income tax.. Less income tax expense (35%)..... . Project net income.........* op e nteem" Total company net income.... . Earnings per share including new project: (8 рoints)

Answer 1

Allen, should go with Plan 1 - Debt financing as it will give higher EPS at $ 3.63 per share, refer working below :

Particulars PLAN 1 PLAN 2 DEBT FUNDED EQUITY FUNDED Calculation Ref. Net income before expansion $ 3,00,000.00 $ 3,00,000.00 [A] 1,00,000.00 Project income before interest and tax Less : Interest expense Project income before tax Less : Income tax expense Project net income $ 1,00,000.00 $ $ -2,500.00 $ $ 97,500.00 $ $ 34,125.00 $ $ 63,375.00 $ 1,00,000.00 35,000.00 65,000.00 [B] Total company net income $ 3,63,375.00$ 3,65,000.00 [C] = [A]+[B] No of shares 1,00,000.00 1,50,000.00 [D] Earning per share including new project $ 3.63 | $ 2.43 [E] =[C]/[D]