Question
Asked Dec 19, 2019
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Brower Co. is considering the following alternative financing plans:
Plan 1
Plan 2
Issue 10% bonds (at face value)
$4,000,000
$2,500,000
Issue preferred $2.50 stock, $25 par
Issue common stock, $10 par
3,000,000
4,000,000
2,500,000
Income tax is estimated at 40% of income.
Determine the earnings per share of common stock, assuming that income before
bond interest and income tax is $2,000,000.
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Brower Co. is considering the following alternative financing plans: Plan 1 Plan 2 Issue 10% bonds (at face value) $4,000,000 $2,500,000 Issue preferred $2.50 stock, $25 par Issue common stock, $10 par 3,000,000 4,000,000 2,500,000 Income tax is estimated at 40% of income. Determine the earnings per share of common stock, assuming that income before bond interest and income tax is $2,000,000.

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Expert Answer

Step 1

Determine earnings per share.

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Particulars Plan 1 Plan 2 Net income before interest on bonds and income tax $2,000,000 $2,000,000 $400,000(1) $250,000(2) Less: Interest on bonds $1,600,000 $1,750,000 Income before income tax $640,000(3) s700,000(4) Less: Income tax expense Net income $960,000 $1,050,000 Dividends on preferred stock $300,000(5) Available for dividends on common stock $960,000 $750,000 ÷ 400,000(6):250,000(7) Number of common stock outstanding Earnings per share of common stock $2.40 $3.00

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Step 2

Working Notes:

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Calculate interest on bonds for plan 1. Interest expense = Face value of bonds x Rate of Interest = $4,000,000 × 10% = $400, 000 (1) Calculate interest on bonds for plan 2. Interest expense =Face value of bonds x Rate of Interest = $2,500,000 x 10% = $250, 000 (2) Calculate income tax expense for plan 1. Income before income tax Income tax expense = xIncome tax percentage (3) = $1, 600, 000 x 40% = $640, 000 Calculate income tax expense for plan 2. (Income before income tax Income tax expense = xIncome tax percentage (4) = $1, 750, 000 x 40% = $700, 000 Calculate dividends on preferred stock for plan 2. $3,000,000 $25 par x $2.50 Dividends on preferred stock = $300, 000

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