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Three different plans for financing an $80,000,000 corporation are under consideration by its organizers. Under each of the following plans, the securities will be issued at their par or face amount, and the income tax rate is estimated at 40% of income: Instructions 1. Determine for each plan the earnings per share of common stock, assuming that the income before bond interest and income tax is $10,000,000. 2. Determine for each plan the earnings per share of common stock, assuming that the income before bond interest and income tax is $6,000,000. 3. Discuss the advantages and disadvantages of each plan.

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Financial Accounting

15th Edition
Carl Warren + 2 others
Publisher: Cengage Learning
ISBN: 9781337272124

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BuyFindarrow_forward

Financial Accounting

15th Edition
Carl Warren + 2 others
Publisher: Cengage Learning
ISBN: 9781337272124
Chapter 14, Problem 1PB
Textbook Problem
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Three different plans for financing an $80,000,000 corporation are under consideration by its organizers. Under each of the following plans, the securities will be issued at their par or face amount, and the income tax rate is estimated at 40% of income:

Chapter 14, Problem 1PB, Three different plans for financing an 80,000,000 corporation are under consideration by its , example  1

Instructions

  1. 1. Determine for each plan the earnings per share of common stock, assuming that the income before bond interest and income tax is $10,000,000.
  2. 2. Determine for each plan the earnings per share of common stock, assuming that the income before bond interest and income tax is $6,000,000.
  3. 3. Chapter 14, Problem 1PB, Three different plans for financing an 80,000,000 corporation are under consideration by its , example  2 Discuss the advantages and disadvantages of each plan.

1.

To determine

Calculate earnings per share of common stock for each plan, if income before bond interest and income tax is $10,000,000.

Explanation of Solution

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(EPS)=Net income Preferred dividends Number of common shares outstanding

Determine Earnings per share of common stock.

ParticularsPlan 1Plan 2Plan 3
Net income before interest on bonds and income tax $10,000,000$10,000,000$10,000,000
Less: Interest on bonds--$3,600,000(1)
Income before income tax$10,000,000$10,000,000$6,400,000
Less: Income tax expense $4,000,000(2)$4,000,000(2)$2,560,000(3)
Net income$6,000,000$6,000,000$3,840,000
Dividends on preferred stock-$2,000,000(4)$1,000,000(5)
Available for dividends on common stock$6,000,000$4,000,000$2,840,000
Number of common stock outstanding÷4,000,000(6)÷2,000,000(7)÷1,000,000(8)
Earnings per share of common stock$1.50$2.00$2.84

Table (1)

Working notes:

(1)

Calculate interest on bonds for plan 3.

Interest expense=Facevalueofbonds×Rate of Interest= $40,000,000×9%=$3,600,000

(2)

Calculate income tax expense for plan 1 and plan 2.

Income tax expense=(Incomebeforeincometax×Incometaxpercentage)=$10,000,000×40%=$4,000,000

(3)

Calculate income tax expense for plan 3

2.

To determine

Calculate earnings per share of common stock for each plan, if income before bond interest and income tax is $6,000,000.

3.

To determine

Describe the advantages and disadvantages of each plan.

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Chapter 14 Solutions

Financial Accounting
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