Question

Ulmer Company is considering the following alternative financing plans: Plan 1 Plan 2 Issue 8% bonds at face value $2,000,000 $1,000,000 Issue preferred stock, $15 par — 1,500,000 Issue common stock, $10 par 2,000,000 1,500,000 Income tax is estimated at 35% of income. Dividends of $1 per share were declared and paid on the preferred stock. Required: Determine the earnings per share of common stock, assuming income before bond interest and income tax is $600,000. Round your answers to two decimal places

Answer 1

Answer:

                                                                PLAN 1          PLAN 2

                                                                     $                   $

Earnings before interest and tax           600,000       600,000

Less: Interest on debt                             160,000        80,000

Profit before tax                                       440,000       520,000

Less: tax @ 35%                                        154,000        182,000

Profit after tax                                            286,000       338,000

Less: Preferred dividend                           100,000        100,000

Profit available for distribution                  186,000        238,000

Earnings per share

= Profit available for distribution              186,000       238,000

  No of common stocks outstanding          200,000      150,000

                                                                      $0.93/share $1.59/share

Explanation:

In the question, we need to determine profit available for distribution, which is earnings before interest and tax less interest on debt less tax less preference dividend. Then, we will divide the profit available for distribution by number of common stocks outstanding. The number of common stock outstanding is face value of common stock divided by par value per unit. Preferred dividend is the product of preferred dividend per share  and number of preferred stocks outstanding. The number of preferred stocks outstanding is the face value of preferred stocks divided by par value of preferred stock per unit.