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Cornerstones of Financial Accounti...

4th Edition
Jay Rich + 1 other
ISBN: 9781337690881

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Cornerstones of Financial Accounti...

4th Edition
Jay Rich + 1 other
ISBN: 9781337690881
Textbook Problem
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Leverage

Cook Corporation issued financial statements at December 31, 2019, that include the following information:

Balance sheet at December 31,2019

Assets $8,000,000

Liabilities $1,200,000

Stockholders' equity (300,000 shares) $6,800,000

Income statement for 2019:

income from operations $1,200,000

Less: Interest expense (100,000)

Income before taxes $1,100,000

Less: Income taxes expense (0,30) (330,000)

Net income $ 770,000

The levels of assets, liabilities, stockholders' equity, and operating income have been stable in recent years; however, Cook Corporation is planning a 51,800,000 expansion program that will increase income from operations by $350,000 to $1,550,000, Cook is planning to sell 8.5% notes at par to finance the expansion.

Required:

3. Suppose income from operations will increase by only $150,000. Would this use of leverage be advantageous to Cook’s stockholders? Explain

To determine

Concept introduction:

Basic Earnings per share:

The Basic Earnings per share is the amount of net income earned by each common share outstanding. The Earnings per share calculated by with help of following formula:

Basic Earnings per share=Net Income - Preferred DividendWeighted Average Common Shares Outstanding

 Net Income available to common stockholder = Net income  Preferred Dividend

To indicate:

If the leverage would be advantageous to the shareholders if the income from operations increase by only $150,000.

Explanation

The Earnings per share before expansion is calculated as follows:

Net income (A) $ 770,000
Number of Equity Shares (B) 300,000
Earnings per share (A/B) $ 2.57

The Earnings per share after expansion is calculated as follows:

Income from Operation (A) $ 1,350,000
Less: Interest Expense (B) 100000+(1800000*8...

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