Q20E
Question
Analyzing alternative plans to raise money
SB Electronics is considering two plans for raising \(4,000,000 to expand operations.
Plan A is to issue 9% bonds payable, and plan B is to issue 500,000 shares of common
stock. Before any new financing, SB Electronics has net income of \)350,000 and
300,000 shares of common stock outstanding. Management believes the company can
use the new funds to earn additional income of $700,000 before interest and taxes.
The income tax rate is 30%. Analyze the SB Electronics situation to determine which
plan will result in higher earnings per share. Use Exhibit 12-6 as a guide.
Step-by-Step Solution
VerifiedPlan A is better than plan B. Hence, issuing bonds payable is better than issuing common stock.
The net income is the income that remains after deducting all expenses and income tax.
| Plan 1 | Plan 2 |
Net Income before the new project | $350,000 | $350,000 |
Expected income of new project before interest and taxes | $700,000 | $700,000 |
Less: Interest Expense | ($360,000) | $0 |
Project income before tax | $340,000 | $700,000 |
Less: Income tax expense (30%) | ($102,000) | ($210,000) |
Project Net Income | $238,000 | $490,000 |
Net Income with the new project | $588,000 | $840,000 |
|
|
|
Earning per share with a new project: |
|
|
Plan 1 ($588,000/300,000) | 1.96 |
|
Plan 2 ($840,000/800,000) |
| 1.05 |