Question 14.1: Alternative Financing Plans Gonzales Co. is considering the ...
Alternative Financing Plans
Gonzales Co. is considering the following alternative plans for financing its company:
| Plan 1 | Plan 2 | |
| Issue 10% bonds (at face value) | — | $2,000,000 |
| Issue common stock, $10 par | $3,000,000 | 1,000,000 |
Income tax is estimated at 40% of income.
Determine the earnings per share of common stock under the two alternative financing plans, assuming that income before bond interest and income tax is $750,000.
| Plan 1 | Plan 2 | |
| Earnings before bond interest and income tax | $ 750,000 | $ 750,000 |
| Interest on bonds | \underline{- } | \underline{\left(200,000\right) ^{2} } |
| Income before income tax | $ 750,000 | $ 550,000 |
| Income tax | \underline{\left(300,000\right) ^{1} } | \underline{\left(220,000\right) ^{3} } |
| Net income | $ 450,000 | $ 330,000 |
| Dividends on preferred stock | \underline{- } | \underline{- } |
| Available for dividends on common stock | $ 450,000 | $ 330,000 |
| Shares of common stock outstanding | \underline{\div 300,000} | \underline{\div 100,000} |
| Earnings per share on common stock | \underline{\underline{\$ 1.50} } | \underline{\underline{\$ 3.30} } |
^{1}\$750,000 × 40\% ^{2}\$2,000,000 × 10\% ^{3}\$550,000 × 40\%
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