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Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094

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BuyFindarrow_forward

Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094
Textbook Problem

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.

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

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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