Northeast Airlines is considering two alternatives for the financing of a purchase of a fleet of airplanes. These two alternatives are:
Issue 60,000 shares of common stock at $45 per share. (Cash dividends have not been paid nor is the payment of any contemplated).
Issue 10%, 10-year bonds at par for $2,700,000.
It is estimated that the company will earn $800,000 before interest and taxes as a result of this purchase. The company has an estimated tax rate of 30% and has 90,000 shares of common stock outstanding prior to the new financing.
Instructions:
Determine the effect on net income and earnings per share for these two methods of financing.