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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:

4. Suppose that income from operations will increase by $200,000 and that Cook could also raise the required $1,800,000 by issuing an additional 100.000 shares of common stock (assume the additional shares were outstanding for the entire year). Which means of financing would stockholders prefer? 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:

The decision of financing with Note or Stock.

Explanation

The decision for financing is taken on the basis of the following analysis:

If Financed with Notes If Financed with Stock
Income from Operation (A) $ 1,400,000 $ 1,400,000
Less: Interest Expense (B) 100000+(1800000*8.5%) $ 253,000 $ 100,000
Income before tax (C) = (A-B) $ 1,147,000 $ 1,300,000

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