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:

1. Issue 60000 shares of common stock at $45 per share. (Cash dividends have not been paid nor is the payment of any contemplated).

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:

1. How much capital is Northeast Airlines considering raising?
2. Determine the effect on net income and earnings per share for both of these methods of financing.
3. Which alternative would you recommend?
4. Why?

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