Brower Co. is considering the following alternative financing plans:

Brower Co. is considering the following alternative financing plans:


Plan 1 Plan 2
Issue 10% bonds (at face value) $4,000,000 $2,500,000
Issue preferred $2.50 stock, $25 par — 3,000,000
Issue common stock, $10 par 4,000,000 2,500,000


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 $2,000,000.


Answer:

Plan 1 Plan 2
Earnings before bond interest and income tax…………… $2,000,000 $2,000,000 1 3
Deduct interest on bonds……………………………………… 400,000 250,000
Income before income tax……………………………………… $1,600,000 $1,750,000
Deduct income tax……………………………………………… 640,0002 700,0004
Net income………………………………………………………… $ 960,000 $1,050,000
Dividends on preferred stock………………………………… 0 300,000
Available for dividends on common stock…………………
Shares of common stock outstanding………………………
$ 960,000
÷ 400,000
$ 750,000
÷ 250,000
Earnings per share on common stock……………………… $ 2.40 $ 3.00
1 $4,000,000 × 10%
2 $1,600,000 × 40%
3 $2,500,000 × 10%
4 $1,750,000 × 40%
5 ($3,000,000 ÷ $25) × $2.50