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Survey of Accounting (Accounting I)

8th Edition
Carl Warren
ISBN: 9781305961883

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BuyFindarrow_forward

Survey of Accounting (Accounting I)

8th Edition
Carl Warren
ISBN: 9781305961883
Textbook Problem

Financing business expansion
You hold a 30% common stock interest in the family-owned business, a vending machine company. Your sister, who is the manager, has proposed an expansion of plant facilities al an expected cost of $6,000,000. Two alternative plans have been suggested as methods of financing the expansion. Each plan is briefly described as follows:
Plan 1, Issue $6,000,000 of 15-year. 8% notes at face amount.
Plan 2. Issue an additional 100.000 shares of $20 par common stock at $25 per share, and $3,500,000 of 15-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 $900,000 in the previous year to $1,200,000 for this year. Your sister has asked you. as the company treasurer, to prepare an analysis of each financing plan.
Prepare a table- indicating the expected earnings per share on the common stock under each plan. Assume an income Lax rate of 25%-

To determine

Concept introduction:

Stock:

The stock, also known as shares, which gives equity ownership and rights in the company in regard to voting for policies and to share profits of the company is termed as stock. The stock is classified as two types, i.e., common and preferred stock.

Bonds:

It is a liability of the company which it has to pay after a certain time along with a fixed rate of interest. This is used by the company for the expansion of the businesses.

To prepare:

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

Explanation

Expected earnings per share as Plan 1 :

    ParticularsAmount
    Income before bond interest and tax  $1,200,000
    Less: Bond interest
      ($6,000,000×0.08)
      $480,000
    Profit before taxes  $720,000
    Less: Income taxes
      ($720,000×0.25)
      $180,000
    Expected earnings after tax  $540,000

  Earning per share on common stock=Expected earnings after taxNumber of shares outstanding=$540,000400,000=$1

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