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1.
Plan 1 Plan 2 Plan 3
Earnings before bond interest and income tax
Bond interest
Income before income tax
Income tax
Net income
Dividends on preferred stock
Earnings available for common stock
Shares of common stock outstanding
Earnings per share on common stock
2.
Plan 1 Plan 2 Plan 3
Earnings before bond interest and income tax
Bond interest
Income before income tax
Income tax
Net income
Dividends on preferred stock
Earnings available for common stock
Shares of common stock outstanding
Earnings per share on common stock
3.
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Earnings per Share of Common Stock
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Earnings per Share of Common Stock
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1.
Plan 1 Plan 2 Plan 3
Earnings before bond interest and income tax 2,100,000$ 2,100,000$ 2,100,000$
Bond interest – – 720,000
2.
Plan 1 Plan 2 Plan 3
Earnings before bond interest and income tax 1,050,000$ 1,050,000$ 1,050,000$
Bond interest – – 720,000
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interest in the company. Also, if earnings before interest and income tax is $2,100,000, it offers the
lowest EPS ($0.70) on common stock.
The principal advantage of Plan 3 is that little additional investment would need to be made by common
shareholders for them to retain their current interest in the company. Also, it offers the largest EPS
($1.44) if earnings before interest and income tax is $2,100,000. Its principal disadvantage is that the
bonds carry a fixed annual interest charge and require the payment of principal. It also requires a
dividend payment to preferred stockholders before a common dividend
can be paid. Finally, Plan 3 provides the lowest EPS ($0.04) if earnings before interest and
income tax is $1,050,000.
Plan 2 provides a middle ground in terms of the advantages and disadvantages described in
the preceding paragraphs for Plans 1 and 3.
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Earnings per Share of Common Stock
Earnings per Share of Common Stock
The principal advantage of Plan 1 is that it involves only the issuance of common stock, which does not
require a periodic interest payment or return of principal, and a payment of preferred dividends is not
required. It is also more attractive to common shareholders than is Plan 2 or 3 if earnings before interest