The financing structure of Warner Corp. is currently as follows:
|
Current liabilities |
$200,000 |
|
Bond payable |
-0- |
|
Preferred shares – $8 dividend per share |
-0- |
|
Common shares – 50,000 shares outstanding |
500,000 |
|
Retained earnings |
300,000 |
Management is considering a plant expansion costing $1,000,000. Several different factors have been considered in a selection of a financing method; the effect of alternative financing methods on earnings per common share remains to be analysed.
The following financing methods are being considered:
|
a. |
Sell $1 million of 12-per cent bonds at face value. |
|
b. |
Sell another 10,000 common shares at $100 per share. |
|
c. |
Sell 10,000 shares of preferred shares at $100. |
Warner is a profitable growth company and income before interest and income taxes is expected to average $200,000 per year; the income tax rate is 40%.
Required:
- Prepare a schedule to compare the effect on earnings per common share of each of the financing options.
- Based on earnings per common share, which method is financially advantageous to common shareholders?
- What other factors should be considered before a final decision is made?
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