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You hold a 25% common stock interest in YouOwnIt, 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: 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.

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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 6CP
Textbook Problem
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You hold a 25% common stock interest in YouOwnIt, 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:

Chapter 14, Problem 6CP, You hold a 25% common stock interest in YouOwnIt, a family-owned construction equipment company. , example  1

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. 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. 2.
    1. a. Chapter 14, Problem 6CP, You hold a 25% common stock interest in YouOwnIt, a family-owned construction equipment company. , example  2 Discuss the factors that should be considered in evaluating the two plans.
    2. b. Chapter 14, Problem 6CP, You hold a 25% common stock interest in YouOwnIt, a family-owned construction equipment company. , example  3 Which plan offers greater benefit to the present stockholders? Give reasons for your opinion.

1.

To determine

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

Explanation of Solution

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

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

ParticularsPlan 1Plan 2
Shares of Common Stock400,000950,000
 
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

2(a)

To determine

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

(b)

To determine

Explain the plan that offers greater benefit to the present stockholders.

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Chapter 14 Solutions

Financial Accounting
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