1)Wilkinson Co. Is Considering the Following Alternative Financing Plans

1)Wilkinson Co. is considering the following alternative financing plans.

Plan 1Plan 2

$1,000,000$500,000

------700,000

1,000,000800,000

Issue 12% bonds (at face value)

Issue preferred $2 stock, $10 per share

Issue common stock, $10

Income tax is estimated at 40% of income.

Determine the earnings per share of common stock, assuming income before bond interest and income tax is $400,000.

2)What is the present value of $7,000 to be received in 10 years, if the market rate of interest is 7% compounded annually?

3)On the first day of fiscal year, a company issues a $500,000, 10%, 10-year bond that pays semiannual interest of $25,000 ($500,000 x 10 x ½),receiving cash of $463,202.

Journalize the bond issuance.

4)Using the bond from question 3, journalize the first interest payment and the amortization of the related bond discount.

5)A company issues a $2,000,000, 12%, five-year bond that pays semiannual interest of $120,000 ($2,000,000 x 12% x ½), receiving cash of $2,154,429. Journalize the bond issuance.

6)Three different plans for financing a #30,000,000 corporation are under consideration by its organizers. Under each of the following plans, the securities will be issued at their par or face amt, and the income tax rate is estimated at 40% of income.

Plan 1Plan 2Plan 3

8% bonds ______$20,000,000

Preferred $2 stock, $50 par _____$20,000,000$10,000,000

Common stock, $10 par $40,000,00020,000,00010,000,000

Total$40,000,00040,000,00040,000,000

Instructions

1)Determine for each plan the earnings per share of common stock, assuming that the income before bond interest and income tax is $20,000,000.

Plan 1Plan 2Plan 3

Earnings before interest and income tax...... $20,000,000$20,000,000$20,000,000

Deduct interest on bonds...... ——1,600,000

Income before income tax...... $20,000,000$20,000,000$18,400,000

Deduct income tax...... 8,000,0008,000,0007,360,000

Net income...... $12,000,000$12,000,000$11,040,000

Dividends on preferred stock...... —800,000400,000

Available for dividends on common stock...... $12,000,000$11,200,000$10,640,000

Shares of common stock outstanding...... /4,000,000/2,000,000/1,000,000

Earnings per share on common stock...... $3.00$5.60$10.64

2)Determine for each plan the earnings per share of common stock, assuming that the income before bond interest and income tax is $2,600,000.

Plan 1Plan 2Plan 3

Earnings before interest and income tax...... $2,600,000$2,600,000$ 2,600,000

Deduct interest on bonds...... —— 1,600,000

Income before income tax...... $2,600,000$2,600,000$ 1,000,000

Deduct income tax...... 1,040,0001,040,000 400,000

Net income...... $1,560,000$1,560,000$ 600,000

Dividends on preferred stock...... —800,000 400,000

Available for dividends on common stock...... $1,560,000$760,000$ 200,000

Shares of common stock outstanding...... /4,000,000/2,000,000/ 1,000,000

Earnings per share on common stock...... $0.39$0.38$0.20

3)Discuss the advantages and disadvantages of each plan.

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 and income tax is $2,600,000. In this case, it has the largest EPS ($0.39).

The principal disadvantage of Plan 1 is that it requires an additional investment by present

common shareholders to retain their current interest in the company. Also, if earnings before

interest and income tax is $20,000,000, this plan offers the lowest EPS ($3.00) 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 ($10.64) if earnings

before interest and income tax is $20,000,000. 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 ($0.20) if earnings before interest and income tax is $2,600,000.

Plan 2 provides a middle ground in terms of the advantages and disadvantages described in the

preceding paragraphs for Plans 1 and 3.

4)3) The following selected transactions relate to certain securities acquired by Wildflower Blueprints Inc., whose fiscal year ends on Dec 31:
2007
Sept 1. Purchased $600,000 of Wilson Co 20-year, 10% bonds dated July 1, 2007, directly from the issuing co, for $578,580 plus accrued interest of $10,000.
Dec 31. Received the semiannual interest on the wilson co bonds.
31. Recorded bond discount amortization of $360 onthe wilson company bonds.
The amortization amount was determined by using the straight-line method.
(Assuming that all intervening transactions and adjustments have been properly recorded and that the number of bonds owned has not changed from Dec. 31, 2007, to Dec 31, 2011.)
2012
June 30. Received the semiannual interest on the wilson co bonds.
Oct 31. Sold one-half of the wilson co bonds at 97 plus accrued interest. The broker deducted $400 for commission, etc., remitting the balance. Prior to the sale, $450 of discount on one-half of the bonds was amortized, reducing the carrying amount of those bonds to $292,080.
Dec 31. Received the semiannual interest on the wilson co bonds.
31. Recorded bond discount amortization of $540 on the wilson co bonds.

2007

Sept.1Investment in Wilson Company Bonds...... 578,580

Interest Revenue ($600,000 × 10% × 2/12)...... 10,000

Cash...... 588,580

Dec.31Cash...... 30,000

Interest Revenue...... 30,000

31Investment in Wilson Company Bonds...... 360*

Interest Revenue...... 360

*[($600,000 – $578,580)/238 months]x4.

2012

June30Cash...... 30,000

Interest Revenue...... 30,000

Oct.31Investment in Wilson Company Bonds...... 450

Interest Revenue...... 450

31Cash...... 300,600*

Loss on Sale of Investments...... 1,480

Investment in Wilson Company Bonds...... 292,080

Interest Revenue...... 10,000

*($300,000 × 0.97) + ($300,000 × 10% × 4/12) – $400

Dec.31Cash...... 15,000

Interest Revenue...... 15,000

31Investment in Wilson Company Bonds...... 540

Interest Revenue...... 540