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Effect of Financing on Earnings Per Share

Three different plans for financing a $2,000,000 corporation are 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
10% bonds _ _ $1,000,000
Preferred 10% stock, $100 par _ $1,000,000 500,000
Common stock, $2 par $2,000,000 1,000,000 500,000
Total $2,000,000 $2,000,000 $2,000,000
Round the answers to nearest cent.

Instructions:

1. Determine for each plan the earnings per share of common stock, assuming that the income before bond interest and income tax is $4,000,000.

Earnings per share of common stock
Plan 1 $fill in the blank 1
2.40
per share
Plan 2 $fill in the blank 2
2.28
per share
Plan 3 $fill in the blank 3
4.36
per share

2. Determine for each plan the earnings per share of common stock, assuming that the income before bond interest and income tax is $1,900,000.

Earnings per share of common stock
Plan 1 $fill in the blank 4
1.14
per share
Plan 2 $fill in the blank 5
per share
Plan 3 $fill in the blank 6
4.36
per share
3. Regarding the three plans, which of the following statements is true?

Plan 3 requires a dividend payment to preferred stockholders before a common dividend can be paid.

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1. Set up a column for each plan. Begin with earnings of $4,000,000 for the plans. Subtract bond interest if applicable. Subtract the income tax based on 40% of earnings after interest. Subtract preferred dividends if applicable. Divide earnings available for common stock by the number of common shares outstanding (Common stock amount ÷ Par).

2. Set up a column for each plan. Begin with earnings of $1,900,000 for the plans. Subtract bond interest if applicable. Subtract the income tax based on 40% of earnings after interest. Subtract preferred dividends if applicable. Divide earnings available for common stock by the number of common shares outstanding (Common stock amount ÷ Par).

3. Before answering this question, review your answers in requirements (1) and (2) of the problem.