Question

Alternative Financing Plans Frey Co. is considering the following alternative financing plans: Plan 1 Plan 2 $1,080,000 Issue 10% bonds (at face value) Issue preferred $1 stock, $10 par Issue common stock, $5 par $540,000 900,000 720,000 1,080,000 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 $324,000. Enter answers in dollars and cents, rounding to two decimal places. Plan 1 Earnings per share on common stock Earnings per share on common stock Plan 2

Answer 1

Income Statement
Particulars	PLAN-1	PLAN-2
Earnings before interest & tax	$324,000	$324,000
Less: Interest expenses [$1,080,000 x 10%] & [$540,000 x 10%]	$108,000	$54,000
Earnings before tax	$216,000	$270,000
Less: Tax at 40%	$86,400	$108,000
Net Income	$129,600	$162,000
Less: Preferred dividends	$0	$90,000
Net Income available to common stockholders	$129,600	$72,000
Number of common shares outstanding [$1,080,000 / $5] & [$720,000 / $5]	216,000 shares	144,000 shares
Earnings per share on common stock	$0.60 per share	$0.50 per share