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.

Question

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.

Accepted Answer

	Plan 1	Plan 2
Earnings before bond interest and income tax	$ 750,000	$ 750,000
Interest on bonds	[latex]\underline{- } [/latex]	[latex]\underline{\left(200,000\right) ^{2} } [/latex]
Income before income tax	$ 750,000	$ 550,000
Income tax	[latex]\underline{\left(300,000\right) ^{1} } [/latex]	[latex]\underline{\left(220,000\right) ^{3} } [/latex]
Net income	$ 450,000	$ 330,000
Dividends on preferred stock	[latex]\underline{- } [/latex]	[latex]\underline{- } [/latex]
Available for dividends on common stock	$ 450,000	$ 330,000
Shares of common stock outstanding	[latex]\underline{\div 300,000} [/latex]	[latex]\underline{\div 100,000} [/latex]
Earnings per share on common stock	[latex]\underline{\underline{\$ 1.50} } [/latex]	[latex]\underline{\underline{\$ 3.30} } [/latex]

[latex]^{1}\$750,000 × 40\% ^{2}\$2,000,000 × 10\% ^{3}\$550,000 × 40\% [/latex]

Question 14.1: Alternative Financing Plans Gonzales Co. is considering the ...

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