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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.
a. Discuss the factors that should be considered in evaluating the two plans.
b. Which plan offers the greater benefit to the present stockholders? Give reasons for your opinion.

To determine

(a)

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 discuss:

The factors that should be considered while evaluating the two plans.

Explanation

The two given plans include the issue of bonds and the net income is being reduced by the interest of such bonds but the value of bonds are different i.e. when the bonds are issued only as under plan 1 the EPS comes out to be $1

To determine

(b)

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.

The best option plan for the stakeholders for achieving greater benefits.

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