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Chapter 12: Q20E (page 659)

Analyzing alternative plans to raise money

SB Electronics is considering two plans for raising \(4,000,000 to expand operations.

Plan A is to issue 9% bonds payable, and plan B is to issue 500,000 shares of common

stock. Before any new financing, SB Electronics has net income of \)350,000 and

300,000 shares of common stock outstanding. Management believes the company can

use the new funds to earn additional income of $700,000 before interest and taxes.

The income tax rate is 30%. Analyze the SB Electronics situation to determine which

plan will result in higher earnings per share. Use Exhibit 12-6 as a guide.

Short Answer

Expert verified

Plan A is better than plan B. Hence, issuing bonds payable is better than issuing common stock.

Step by step solution

01

Definition of the net income

The net income is the income that remains after deducting all expenses and income tax.

02

Calculation of earnings per share

Plan 1

Plan 2

Net Income before the new project

$350,000

$350,000

Expected income of new project before interest and taxes

$700,000

$700,000

Less: Interest Expense

($360,000)

$0

Project income before tax

$340,000

$700,000

Less: Income tax expense (30%)

($102,000)

($210,000)

Project Net Income

$238,000

$490,000

Net Income with the new project

$588,000

$840,000

Earning per share with a new project:

Plan 1 ($588,000/300,000)

1.96

Plan 2 ($840,000/800,000)

1.05

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Most popular questions from this chapter

Analyzing and journalizing bond transactions

On January 1, 2018, Nurses Credit Union (NCU) issued 8%, 20-year bonds payablewith face value of $600,000. The bonds pay interest on June 30 and December 31.

Requirements

1. If the market interest rate is 7% when NCU issues its bonds, will the bonds bepriced at face value, at a premium, or at a discount? Explain.

2. If the market interest rate is 9% when NCU issues its bonds, will the bonds bepriced at face value, at a premium, or at a discount? Explain.

3. The issue price of the bonds is 92. Journalize the following bond transactions:

a. Issuance of the bonds on January 1, 2018.

b. Payment of interest and amortization on June 30, 2018.

c. Payment of interest and amortization on December 31, 2018.

d. Retirement of the bond at maturity on December 31, 2037, assuming the lastinterest payment has already beenrecorded.

Journalizing liability transactions and reporting them on the balance sheet

The following transactions of Great Value Pharmacies occurred during 2018 and 2019:

2018

Mar. 1 Borrowed \(390,000 from Bartow Bank.The six-year, 13% note requires payments due annually, on March 1. Each payment consists of \)65,000 principal plus one year’s interest.

Dec. 1 Mortgaged the warehouse for \(350,000 cash with Saylor Bank. The mortgagerequires monthly payments of \)7,000. The interest rate on the note is 9% andaccrues monthly. The first payment is due on January 1, 2019.

31 Recorded interest accrued on the Saylor Bank note.

31 Recorded interest accrued on the Bartow Bank note.

2019

Jan. 1 Paid Saylor Bank monthly mortgage payment.

Feb. 1 Paid Saylor Bank monthly mortgage payment.

Mar. 1 Paid Saylor Bank monthly mortgage payment.

1 Paid first installment on note due to Bartow Bank.

Requirements

1. Journalize the transactions in the Great Value Pharmacies general journal. Roundto the nearest dollar. Explanations are not required.

2. Prepare the liabilities section of the balance sheet for Great Value Pharmacies onMarch 1, 2019 after all the journal entries are recorded.

In regard to a bond discount or premium, what is the straight-line amortization

method?

Determining bond prices and interest expense

Jones Company is planning to issue $490,000 of 9%, five-year bonds payable to

borrow for a major expansion. The owner, Shane Jones, asks your advice on some

related matters.

Requirements

1. Answer the following questions:

a. At what type of bond price Jones Company will have total interest expense

equal to the cash interest payments?

b. Under which type of bond price will Jones Company’s total interest expense be

greater than the cash interest payments?

c. If the market interest rate is 12%, what type of bond price can Jones Company

expect for the bonds?

2. Compute the price of the bonds if the bonds are issued at 89.

3. How much will Jones Company pay in interest each year? How much will Jones

Company’s interest expense be for the first year?

Using the effective-interest amortization method

On December 31, 2018, when the market interest rate is 6%, Benson Realty issues

\(700,000 of 6.25%, 10-year bonds payable. The bonds pay interest semiannually. Benson

Realty received \)713,234 in cash at issuance.

Requirements

1. Prepare an amortization table using the effective interest amortization method for

the first two semiannual interest periods. (Round to the nearest dollar.)

2. Using the amortization table prepared in Requirement 1, journalize issuance of the

bonds and the first two interest payments.
See all solutions

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