The CFO of Anne's Toy Car Company is doing some sensitivity analysis to determine the best level of debt for the firm. The company has $12 million in assets. Half of those assets are financed with long term debt at 10% and half with common stock that has a par value of $8. The CFO is considering two different refinancing plans. One plan will use more equity and one will use more debt. The company's tax rate is 30%. Anne's Toy Car Company earns a return on assets before interest and taxes of 10%. Under the greater debt plan, a $3 million long term bond issue would be sold at an interest rate of 12% and 375,000 shares of common stock would be purchased at a market price of $8 per share and then retired. Under the greater equity plan, 375,000 shares of common stock would be sold at $8 per share and the $3 million in proceeds would be used to reduce long-term debt.
Find earnings per share under (1) the current situation, (2) the greater debt proposal, and (3) the greater equity proposal. In footnotes explain your computations for (a) interest expense and (b) number of shares outstanding in each alternative.