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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

Financing business expansion

You hold a 25% common stock interest in YouOwnlt, a family-owned construction equipment company. Your sister, who is the manager, has proposed an expansion of plant facilities at an expected cost of $26,000,000. Two alternative plans have been suggested as methods of financing the expansion. Each plan is briefly described as follows:

Plan 1. Issue $26,000,000 of 20-year, 8% notes at face amount

Plan 2. Issue an additional 550,000 shares of $10 par common stock at $20 per share, and $15,000,000 of 20-year, 8% notes at face amount

The balance sheet as of the end of the previous fiscal year is as follows

You Ownlt, Inc.  
Balance Sheet  
December 31, 20Y7  
Assets  
Current assets....................................................... $15,000,000
Property, plant, and equipment....................................... 22,500,000
Total assets.......................................................... $37,500,000
Liabilities and Stockholders' Equity  
Liabilities............................................................ $ 11,250,000
Common stock, $10.................................................. 4,000,000
Paid-in capital in excess of par........................................ 500,000
Retained earnings.................................................... 21,750,000
Total liabilities and stockholders' equity............................... $ 37,500,000

Net income has remained relatively constant over the past several years. The expansion program is expected to increase yearly income before bond interest and income tax from $2,667,000 in the previous year to $5,000,000 for this year. Your sister has asked you, as the company treasurer, to prepare an analysis of each financing plan.

1. Prepare a table indicating the expected earnings per share on the common stock under each plan. Assume an income tax rate of 40%. Round to the nearest cent.

2. a. Discuss the factors that should be considered in evaluating the two plans,

b. Which plan offers greater benefit to the present stockholders? Give reasons for your opinion

1.

To determine

Earnings per share (EPS): It refers to the share of earnings earned by the shareholder on each owned. The formula to calculate the earnings per share is as follows:

Earnings per share} = Net income – Preferred dividendsWeighted average number of shares outstanding

To Prepare: a table indicating the expected earnings per share on the common stock under each plan.

Explanation

Prepare a table indicating the expected earnings per share on the common stock under each plan.

Particulars Plan 1 Plan 2
Shares of Common Stock 400,000 950,000
 
Earnings before bond interest and income tax $5,000,000 $5,000,000
Less: Interest on Bonds ($2,080,000) ($1,200,000)
Income before income tax $2,920,000 $3,800,000
Less: Income Tax (40%) ($1,168,000) ($1,520,000)
Net income $1,752,000 $2,280,000
Earnings per share $4.38 (1) $2.40(2)

Table (1)

Working notes:

Determinethe earnings per share for Plan 1 and Plan 2

Plan 1

Earnings per share

2(a)

To determine

To discuss: the factors that should be considered in evaluating the two plans.

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