Quantitative Reasoning Problem 3 ACC 122 Assignment is to be completed as a Word

Question

Quantitative Reasoning Problem 3

ACC 122

Assignment is to be completed as a Word Document, PDF, or on notebook paper and submitted through Moodle

Compare two alternatives for financing - Issuance of common stock vs. Issuance of bonds.

Northeast Airlines is considering two alternatives for the financing of the purchase of a fleet of airplanes. These two alternatives are:

2. Issue 10%, 10-year bonds at face value for $2,700,000.

It is estimated that the company will earn $800,000 before interest and taxes as a result of this purchase. The company has an estimated tax rate of 30% and has 90000 shares of common stock outstanding prior to the new financing.

Instructions:

Show calculations as well as explain in words your thinking behind your calculations and conclusions.

Explanation / Answer

1. Northeast Airlines is considering to raise $2700000

2. Effect on Net Income and EPS ( Amount in $)

Alternative 1

Issuing Common stock ( 60000 shares @ $45 each)

Alternative 2

Issuing 10% bonds of $2700000

(270000)

2700000 * 10%

150000

(90000 + 60000)

90000

Since the Earning per share is higher under alternative 2 , the same method of financing shall be recommended.

The investors are always concerned with higher EPS and therefore Alternative 2 is recommended.

Particulars

Alternative 1

Issuing Common stock ( 60000 shares @ $45 each)

Alternative 2

Issuing 10% bonds of $2700000

Estimated Earnings before Interest and Tax 800000 800000 Less: Interest -

(270000)

2700000 * 10%

Earnings Before Tax 800000 530000 Less : Tax @ 30% (240000) (159000) Earnings after tax (A) 560000 371000 No. of share outstanding (B)

150000

(90000 + 60000)

90000

Earnings Per Share (A/B) 3.733 4.122

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