On December 31, 2016, the equity accounts of Financial Solutions, Inc., contained the following balances: Common stock

Question:

On December 31, 2016, the equity accounts of Financial Solutions, Inc., contained the following balances:

Common stock ($10 par, 100,000 shares authorized)

50,000 shares issued and outstanding...............500,000

Retained earnings.......................................500,000

For the year 2016, the corporation had net income before income taxes of $200,000, income taxes of $70,000, and net income after taxes of $130,000. The corporation's tax rate is 35 percent.

An expansion of the existing plant at a cost of $500,000 is planned. The corporation's president, who owns 60 percent of the corporation's common stock, estimates that the expansion would result in an increased net income of approximately $200,000 before interest and taxes. The financial vice president forecasts that the increase would be only $100,000. Round all calculations to nearest dollar.

Management is considering two possibilities for financing:

a. Issuance of 40,000 additional shares of common stock for $15 per share

b. Issuance of $500,000 face amount, 10-year, 6 percent bonds payable, secured by a mortgage lien on the plant

Assume that profits from existing operations will remain the same.

INSTRUCTIONS

1. Assume that the president's estimate of net income from the new plant is correct. Prepare a two-column table for each of the proposed financing plans. Show the following items: (a) total net income before interest and tax; (b) total bond interest; (c) total income tax; (d) total income after tax; (e) present income after tax; (f) increase or decrease in total income after bond interest and tax; (g) present earnings per share of common stock (compute earnings per share by dividing the net income after taxes by the number of shares of common stock outstanding); (h) estimated earnings per share of common stock.

2. Construct a similar table, assuming the financial vice president's estimate of earnings is correct.

3. Write a brief comment on the results of your analysis.

Analyze:

Assume the company issued 40,000 shares of common stock and net income before taxes was $350,000. Would shareholders have realized an increase or decrease in earnings per share over fiscal 2016?

Common Stock
Common stock is an equity component that represents the worth of stock owned by the shareholders of the company. The common stock represents the par value of the shares outstanding at a balance sheet date. Public companies can trade their stocks on...
Corporation
A Corporation is a legal form of business that is separate from its owner. In other words, a corporation is a business or organization formed by a group of people, and its right and liabilities separate from those of the individuals involved. It may...
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Related Book For  book-img-for-question

College Accounting Chapters 1-30

ISBN: 978-0077862398

14th edition

Authors: John Price, M. David Haddock, Michael Farina

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