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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

BuyFind

Accounting

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

Accounting

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

Solutions

Chapter
Section
Chapter 14, Problem 14.6CP
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

Expert Solution

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 of Solution

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

Expert Solution

2(a)

To determine

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

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Chapter 14 Solutions

Accounting
Show all chapter solutions
Ch. 14 - Alternative financing plans Frey co. is...Ch. 14 - Alternative financing plans Brower co. is...Ch. 14 - Issuing bonds at face amount On January 1, the...Ch. 14 - Issuing bonds at face amount On January 1, the...Ch. 14 - Issuing bonds at a discount On the First day of...Ch. 14 - Issuing bonds at a discount On the first day of...Ch. 14 - Discount amortization Using the bond from Practice...Ch. 14 - Discount amortization Using the bond from Practice...Ch. 14 - Issuing bonds at a premium On the first day of the...Ch. 14 - Issuing bonds at a premium On the first day of the...Ch. 14 - Premium amortization Using the bond from Practice...Ch. 14 - Premium amortization Using the bond from Practice...Ch. 14 - A Redemption of bonds payable A 1,500,000 bond...Ch. 14 - Redemption of bonds payable A 1,200,000 bond issue...Ch. 14 - Journalizing installment notes On the first day of...Ch. 14 - Journalizing installment notes On the first day of...Ch. 14 - Times interest earned Berry Company reported the...Ch. 14 - Times interest earned Aver ill Products Inc....Ch. 14 - Effect of financing on earnings per share Domanico...Ch. 14 - Evaluate alternative financing plans Based on the...Ch. 14 - Corporate financing The financial statements for...Ch. 14 - Bond price Stone Energy Corporation's 7.5% bonds...Ch. 14 - Entries for issuing bonds Thomson Co. products and...Ch. 14 - Entries for issuing bonds and amortizing discount...Ch. 14 - Entries for issuing bonds and amortizing premium...Ch. 14 - Entries for issuing and calling bonds; loss Adele...Ch. 14 - Entries for issuing and calling bonds; gain Emil...Ch. 14 - Entries for installment note transactions On the...Ch. 14 - Entries for installment note transactions On...Ch. 14 - Entries for installment note transactions On...Ch. 14 - Reporting bonds At the beginning of the current...Ch. 14 - Times interest earned The following data were...Ch. 14 - Times interest earned Loomis, Inc. reported the...Ch. 14 - Times interest earned lacouva Company reported the...Ch. 14 - Present value of amounts due Tommy John is going...Ch. 14 - Present value of an annuity Determine the present...Ch. 14 - Present value of an annuity On January 1, you win...Ch. 14 - Present value of an annuity Assume the same data...Ch. 14 - Present value of bonds payable; discount Pinder...Ch. 14 - Present value of bonds payable; premium Moss Co....Ch. 14 - Amortize discount by interest method On the first...Ch. 14 - Amortize premium by interest method Shunda...Ch. 14 - Compute bond proceeds, amortizing premium by...Ch. 14 - Compute bond proceeds, amortizing discount by...Ch. 14 - Effect of financing on earnings per share Three...Ch. 14 - Bond discount, entries for bonds payable...Ch. 14 - Bond premium, entries for bonds payable...Ch. 14 - Entries for bonds payable and installment note...Ch. 14 - Bond discount, entries for bonds payable...Ch. 14 - Bond premium, entries for bonds payable...Ch. 14 - Effect of financing on earnings per share Three...Ch. 14 - Bond discount, entries for bonds payable...Ch. 14 - Bond premium, entries for bonds payable...Ch. 14 - Entries for bonds payable and installment note...Ch. 14 - Bond discount entries for bonds payable...Ch. 14 - Bond premium, entries for bonds payable...Ch. 14 - Ethics in Action CEG Capital Inc. is a large...Ch. 14 - Communication Nordbock Inc. reports the following...Ch. 14 - Present values Alex Kelton recently won the...Ch. 14 - Preferred stock vs. bonds Xentec Inc. has decided...Ch. 14 - Financing business expansion You hold a 25% common...Ch. 14 - Times interest earned The following financial data...

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