Bagan Corporation, a profitable growth company with 200,000 shares of common shares outstanding, is in need of approximately $40 million in new funds to finance required expansion. Currently, there are no other securities outstanding. Management has three options open:
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a. |
Sell $40 million of 12-per cent bonds at face value. |
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b. |
Sell 10% preferred shares: 400,000 shares at $100 per share (dividend $10 per share). |
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c. |
Sell another 200,000 common shares at $200 per share. |
Operating income (before interest and income taxes) on completion of the expansion is expected to average $12 million per year; the income tax rate is 50%.
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Required: |
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1. |
Complete the schedule below and calculate the earnings per common share. |
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12% bonds |
Preferred shares |
Common shares |
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Income before interest and income taxes |
$12,000,000 |
$12,000,000 |
$12,000,000 |
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Less: Interest expense |
____________ |
____________ |
____________ |
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Income before taxes |
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Less: Income taxes at 50% |
____________ |
____________ |
____________ |
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Net income |
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Less: Preferred dividends |
____________ |
____________ |
____________ |
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Net income available to common shareholders |
____________ |
____________ |
____________ |
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Number of common shares outstanding |
____________ |
____________ |
____________ |
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Earnings per common share |
____________ |
____________ |
____________ |
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2. |
Which financing option is most advantageous to the common shareholders? Why? |
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