Suppose Zen Corporation has net income of $600,000 and 200,000 common shares outstanding before a new project. The company needs $1,000,000 for expansion, and management is considering two financing plans:

• Plan 1 is to issue $1,000,000 of 12 percent bonds.

• Plan 2 is to issue 50,000 common shares for $1,000,000.

Zen Corporation management believes the new cash can be invested in operations to earn income of $300,000 before interest and taxes. Given the corporations tax rate of 40 percent, which is the better plan? Why?

HINT-

Comparison of financing plans

EPS Plan 1, $3.54