 # Alternative financing plans Frey co. is considering the following alternative financing plans: Plan1 Plan2 Issue 5% bonds (at face value) $6,000,000$2.000,000 Issue preferred $1 stock.$20 par — 6,000,000 Issue common stock. $25 par 6,000,000 4,000,000 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$800,000. ### Accounting

27th Edition
WARREN + 5 others
Publisher: Cengage Learning,
ISBN: 9781337272094 ### Accounting

27th Edition
WARREN + 5 others
Publisher: Cengage Learning,
ISBN: 9781337272094

#### Solutions

Chapter
Section
Chapter 14, Problem 14.1APE
Textbook Problem

## Alternative financing plansFrey co. is considering the following alternative financing plans:   Plan1 Plan2 Issue 5% bonds (at face value) $6,000,000$2.000,000 Issue preferred $1 stock.$20 par — 6,000,000 Issue common stock. $25 par 6,000,000 4,000,000 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$800,000.

Expert Solution
To determine

Bonds: Bonds are long-term promissory notes that are represented by a company while borrowing money from investors to raise fund for financing the operations.

Common stock: It refers to a security issued in a form of certificate and implies the right of ownership of an investor over a portion of company’s earnings and assets.

Earnings per Share: It is a portion of profit that is earned by each common stock.

Formula:

Earnings per share=Net income Preferred dividends Number of common shares outstanding

To Determine: Earnings per share of common stock.

### Explanation of Solution

Determine Earnings per share of common stock.

 Particulars Plan 1 Plan 2 Net income before interest on bonds and income tax $800,000$800,000 Less: Interest on bonds $300,000(1)$100,000(2) Income before income tax $500,000$700,000 Less: Income tax expense $200,000(3)$280,000(4) Net income $300,000$420,000 Dividends on preferred stock - $300,000(5) Available for dividends on common stock$300,000 $120,000 Number of common stock outstanding ÷ 240,000(6) ÷ 160,000(7) Earnings per share of common stock$1.25 $0.75 Table (1) Working notes: Calculate interest on bonds for plan 1. Interest expense=Facevalueofbonds×Rate of Interest=$6,000,000×5%=$300,000 (1) Calculate interest on bonds for plan 2. Interest expense=Facevalueofbonds×Rate of Interest=$2,000,000×5%=$100,000 (2) Calculate income tax expense for plan 1. Income tax expense=(Incomebeforeincometax×Incometaxpercentage)=$500,000×40%=\$200,000 (3)

Calculate income tax expense for plan 2

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