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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

Effect of financing on earnings per share

Domanico co., which produces and sells biking equipment, is financed as follows:

Bonds payable. 6% (issued at face amount) $5,000,000
Preferred $2.00 stock. $100 par 5,000,000
Common stock. $25 par 5,000,000

Income tax is estimated at 40% of income.

Determine the earnings per share of common stock, assuming that the income before bond interest and income tax is (a) $600,000, (b) $800,000, and (c) $1,200,000.

a)

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, if income before bond interest and income tax is $600,000.

Particulars
Net income before interest on bonds and income tax $600,000
Less: Interest on bonds $300,000(1)
Income before income tax $300,000
Less: Income tax expense $120,000(2)
Net income $180,000
Dividends on preferred stock $100,000(3)
Available of dividends on common stock $80,000
Number of common stock outstanding ÷ 200,000(4)
Earnings per share of common stock $0.40

Table (1)

Working notes:

Calculate interest on bonds.

Interest expense=Facevalueofbonds×Rate of Interest= $5,000,000×6%=$300,000 (1)

Calculate income tax expense

b)

To determine
Earnings per share of common stock.

c)

To determine
Earnings per share of common stock.

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