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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

What does it mean when a company calls a bond?

Analyzing and journalizing bond transactions

On January 1, 2018, Educators Credit Union (ECU) issued 8%, 20-year bonds payablewith face value of $1,000,000. These bonds pay interest on June 30 and December 31.The issue price of the bonds is 109.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 been recorded.

Reporting liabilities

At December 31, MediStat Precision Instruments owes \(52,000 on Accounts

Payable, Salaries Payable of \)12,000, and Income Tax Payable of \(10,000. MediStat

also has \)300,000 of Bonds Payable that were issued at face value that require

payment of a \(35,000 installment next year and the remainder in later years. The

bonds payable require an annual interest payment of \)4,000, and MediStat still

owes this interest for the current year. Report MediStat’s liabilities on its classified

balance sheet on December 31, 2018.

What are the two categories of liabilities reported on the balance sheet? Provide

examples of each.

Retiring bonds payable before maturity

On January 1, 2018, Powell Company issued $350,000 of 10%, five-year bonds

payable

at 102. Powell Company has extra cash and wishes to retire the bonds payable

on

January 1, 2019, immediately after making the second semiannual interest

payment. To

retire the bonds, Powell Company pays the market price of 98.

Requirements

1. What is Powell Company’s carrying amount of the bonds payable on the

retirement

date?

2. How much cash must Powell Company pay to retire the bonds payable?

3. Compute Powell Company’s gain or loss on the retirement of the bonds

payable.
See all solutions

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