   Chapter 14, Problem 14.1BPE

Chapter
Section
Textbook Problem

Alternative financing plansBrower co. is considering the following alternative financing plans:   Plan1 Plan2 Issue 10% bonds (at face value) $4,000,000$2.500,000 Issue preferred $2.50 stock.$20 par — 3,000,000 Issue common stock. $10 par 4000,000 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.

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 $2,000,000$2,000,000 Less: Interest on bonds $400,000(1)$250,000(2) Income before income tax $1,600,000$1,750,000 Less: Income tax expense $640,000(3)$700,000(4) Net income $960,000$1,050,000 Dividends on preferred stock - $300,000(5) Available for dividends on common stock$960,000 $750,000 Number of common stock outstanding ÷ 400,000(6) ÷ 250,000(7) Earnings per share of common stock$2.40 $3.00 Table (1) Working notes: Calculate interest on bonds for plan 1. Interest expense=Facevalueofbonds×Rate of Interest=$4,000,000×10%=$400,000 (1) Calculate interest on bonds for plan 2. Interest expense=Facevalueofbonds×Rate of Interest=$2,500,000×10%=$250,000 (2) Calculate income tax expense for plan 1. Income tax expense=(Incomebeforeincometax×Incometaxpercentage)=$1,600,000×40%=\$640,000 (3)

Calculate income tax expense for plan 2

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