Effect of Financing on Earnings Per Share Three different plans for financing an $2,400,000 corporation is under consideration by its organizers. Under each of the following plans, the securities will be issued at their par or face amount, and the income tax rate is estimated at 40% of income: Plan 1 Plan 2 Plan 3 $1,200,000 600,000 10% Bonds Preferred 10% stock, $40 par Common stock, $2.4 par Total $1,200,000 1,200,000 $2,400,000 600,000 $ 2,400,000 $ 2,400,000 $ 2,400,000 Required: 1. Determine the earnings per share of common stock for each plan, assuming that the income before bond interest and income tax is $4,800,000. Enter answers in dollars and cents, rounding to two decimal places. Earnings Per Share on Common Stock Plan 1 Plan 2 Plan 3
2. Determine the earnings per share of common stock for each plan, assuming that the income before bond interest and income tax is $2,280,000. Enter answers in dollars and cents, rounding to two decimal places. Earnings Per Share on Common Stock Plan 1 Plan 2 advantage Plan 3 disadvantage 3. The principle of preferred dividends of Plan 1 is that it involves only the issuance of common stock, which does not require a periodic interest payment or return of principal, and payment required.

1.

For Plan -1:

Common stock issued @ 2.4 par for $ 2,400,000 ,

so the common stock issued = $ 2,400,000 / 2.4 = 1,000,000 shares.

Now, net income for common shareholders = Net income before Interest and taxes - Interest - taxes -preferred stock dividend.

Net income for common shareholders = $ 4,800,000 - 0 - ( 4,800,000 * 40% ) - 0 = $ 4,800,000 - 1,920,000

Net income for common shareholders = $ 2,880,000

Earning per share = Net income for common shareholders / Number of common shares.

Earning per share = $ 2,880,000 / 1,000,000

Earning per share on common stock = $ 2.88

For Plan-2 :

Common stock issued @ 2.4 par for $ 1,200,000

so the common stock issued = $ 1,200,000 / 2.4 = 500,000 shares.

Preferred stocks 10% par $40 , for $ 1,200,000

Preferred stocks number issued = 1,200,000 / 40 = 30,000 shares.

Thus, dividends on preferred stocks = Par value of shares * dividend rate

Dividend on preferred stocks = $ 1,200,000 * 10% = $ 120,000

Now, net income for common shareholders = Net income before Interest and taxes - Interest - taxes -preferred stock dividend.

Net income for common shareholders = $ 4,800,000 - 0 - ( 4,800,000 * 40% ) - $ 120,000

Net income for common shareholders = $ 4,800,000 - 1,920,000 - 120,000

Net income for common shareholders = $ 2,760,000

Earning per share = Net income for common shareholders / Number of common shares.

Earning per share = $ 2,760,000 / 500,000

Earning per share on common stock = $ 5.52

Plan-3 :

10% Bonds issued = $ 1,200,000 , So the Interest = $ 1200000 * 10% = $ 120,000

Preferred stocks 10% , 40 par for $ 600,000 , So , preferred stocks dividend = $ 600000 * 10% = $ 60,000

Common stock issued @ 2.4 par for $ 600,000

so the common stock issued = $ 600,000 / 2.4 = 250,000 shares.

Now, net income for common shareholders = Net income before Interest and taxes - Interest - taxes -preferred stock dividend.

Net income for common shareholders = $ 4,800,000 - $120,000  - { ( 4,800,000 - 120,000) * 40% } - $ 60,000

Net income for common shareholders = $ 4,800,000 - $ 120,000 - ( 4680000 * 40%)  - 60,000

Net income for common shareholders = $ 4800000 - 120000 - 1872000 - 60000

Net income for common shareholders = $ 2,748,000

Earning per share = Net income for common shareholders / Number of common shares.

Earning per share = $ 2,748,000 / 250,000

Earning per share on common stock = $ 10.99

Thus,

2.

In same way as solved above the Earning per share for part 2 will be as follows:

Plan -1 :

Earning per share = Net income for common shareholders / Number of common stockholders.

Earning per share = ( $ 2280000 - 0 - ( 2280000 *40%) - 0 ) / 1000000

Earning per share = $ 1,368,000 / 1000000

Earning per share = 1.37

Plan-2 :

Earning per share = Net income for common shareholders / Number of common stockholders.

Earning per share = ( $ 2280000 - 0 - ( 2280000 *40%) - 120000 ) / 500000

Earning per share = $ 1248000 / 500000

Earning per share = 2.50.

Plan-3

Earning per share = Net income for common shareholders / Number of common stockholders.

Earning per share = ( $ 2280000 - 120,000 - { ( 2280000 - 120,000 ) *40%) } - 60,000 ) / 250,000

Earning per share = $ 1236000 / 250,000

Earning per share = 4.94.

3.

The Principal advantage of Plan 1 is that it involves only the issuance of common stock, which does not require a periodic interest payment or return of principal , and a payment of preferred dividends is not required.