Response to the following problem:
The financing structure of Warner Corp. is currently as follows:
Current liabilities $200,000
Bond payable -0-
Preferred shares - $8 dividend per share -0-
Common shares - 50,000 shares outstanding 500,000
Retained earnings 300,000
Management is considering a plant expansion costing $1,000,000. Several different factors have been considered in a selection of a financing method; the effect of alternative financing methods on earnings per common share remains to be analysed.
The following financing methods are being considered:
a. Sell $1 million of 12-per cent bonds at face value.
b. Sell another 10,000 common shares at $100 per share.
c. Sell 10,000 shares of preferred shares at $100.
Warner is a profitable growth company and income before interest and income taxes is expected to average $200,000 per year; the income tax rate is 40%
Required:
1. Prepare a schedule to compare the effect on earnings per common share of each of the financing options.
2. Based on earnings per common share, which method is financially advantageous to common shareholders?
3. What other factors should be considered before a final decision is made?