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PR 14-1B Effect of financing on earnings per share OBJ. 1 Three different plans for financing an $80,000,000 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: (Continued) Long-Term Liabilities: Bonds and Notes Plan 1 Plan 2 Plan 3 9% Bonds $40,000,000 Preferred 5% stock, $25 par $40,000,000 20,000,000 Common stock, $20 par $80,000,000 40,000,000 20,000,000 Total $80,000,000 $80,000,000 $80,000,000 Instructions 1. Determine for each plan the earnings per share of common stock, assuming that the income before bond interest and income tax is $10,000,000. 2. Determine for each plan the earnings per share of common stock, assuming that the income before bond interest and income tax is $6,000,000. 3. Discuss the advantages and disadvantages of each plan. Plan 1 $ 10,000,000 Plan 2 $ 10,000,000 Earnings before bond interest and income tax Bond interest Income before income tax Income tax Net income Dividends on preferred stock Earnings available for common stock - Shares of common stock outstanding Earnings per share on common stock $ 10,000,000 4,000,000 $ 6,000,000 $ 10,000,000 4,000,000 $ 6,000,000 2,000,000 $ 4,000,000 2,000,000 2.00 Plan 3 $ 10,000,000 3,600,000 $ 6,400,000 2,560,000 $ 3,840,000 1,000,000 $ 2,840,000 1,000,000 $ $ 6,000,000 4,000,000 $ 1.50 $ 2.84 Earnings per Share of Common Stock Plan 2 $ 6,000,000 * Plan 1 Earnings before bond interest and income tax $ 6,000,000 Bond interest Income before income tax $ 6,000,000 Income tax 2,400,000 Net income $ 3,600,000 Dividends on preferred stock Earnings available for common stock $ 3,600,000 - Shares of common stock outstanding 4,000,000 Earnings per share on common stock $ 0.90 $ 6,000,000 2,400,000 $ 3,600,000 Plan 3 $ 6,000,000 3,600,000 $ 2,400,000 960,000 $ 140,000 1,000,000 $ 440,000 1,000,000 $ 0.44 $ 1,600,000 2,000,000 $ 0.80