Response to the following problem:
Bagan Corporation, a profitable growth company with 200,000 shares of common shares outstanding, is in need of approximately $40 million in new funds to finance required expansion. Currently, there are no other securities outstanding. Management has three options open:
a. Sell $40 million of 12-per cent bonds at face value.
b. Sell 10% preferred shares: 400,000 shares at $100 per share (dividend $10 per share).
c. Sell another 200,000 common shares at $200 per share. Operating income (before interest and income taxes) on completion of the expansion is expected to average $12 million per year; the income tax rate is 50%.
Required:
1. Complete the schedule below and calculate the earnings per common share.
12% bonds Preferred shares Common shares
Income before interest and income taxes $12,000,000 $12,000,000 $12,000,000
Less: Interest expense
Income before taxes
Less: Income taxes at 50%
Net Income
Less: Preferred dividends
Net income available to common shareholders
Number of common shares outstanding
Earnings per common share
2. Which financing option is most advantageous to the common shareholders? Why?