Texcar Co. is considering the following alternative financing plans:

Texcar Co. is considering the following alternative financing plans:


Plan 1 Plan 2
Issue 6% bonds (at face value) $6,000,000 $5,000,000
Issue preferred $3 stock, $30 par — 3,000,000
Issue common stock, $20 par 6,000,000 4,000,000


Income tax is estimated at 40% of income.

Determine the earnings per share of common stock, assuming income before bond interest and income tax is $1,200,000.


Answer:

Plan 1 Plan 2
Earnings before bond interest and income tax…………… $1,200,000 $1,200,000 1
Deduct interest on bonds……………………………………… 360,000 300,000
Income before income tax…………………………………… $ 840,000 $ 900,000 2 4
Deduct income tax……………………………………………… 336,000 360,000
Net income……………………………………………………… $ 504,000 $ 540,000
Dividends on preferred stock………………………………… 0 300,000
Available for dividends on common stock………………… $ 504,000 $ 240,000
Shares of common stock outstanding……………………… ÷ 300,000 ÷ 200,000
Earnings per share on common stock……………………… $ 1.68 $ 1.20
1 $6,000,000 × 6%
2 $840,000 × 40%
3 $5,000,000 × 6%
4 $900,000 × 40%
5 ($3,000,000 ÷ $30) × $3.00