TWo Methods of Financing Bondholders Stockholders Why issue bonds rather than stock? Bonds debt)-Interest payments to bondholders are an expense that reduces taxable income Stock equity-Dividend payments are made from after tax net income and retained earnings Earnings per share on common stock can often be increased by issuing bonds rather than additional stock c13-6
C13 - 6 Two Methods of Financing Bondholders Bonds (debt) – Interest payments to bondholders are an expense that reduces taxable income. Stock (equity) – Dividend payments are made from after tax net income and retained earnings. Earnings per share on common stock can often be increased by issuing bonds rather than additional stock. Why issue bonds rather than stock? Stockholders
Alternative Financing Plans-$800, 000 Earnings Plan 1 Plan 2 Plan 3 12 bonds $2,000,000 Preferred 9% stock, $50 par $2,000,0001,000,000 Common stock,$10par$4000,0002,000,0001,000,000 Total $4,000,000$4,000,000$4,000,000 Earnings before interest and income tax $800,000$800,000$800,000 Deduct interest on bonds 240,000 Income before income tax 800,000 800, 000 $ 560,000 Deduct income tax 320,000320,000224,000 Net income $480,000$480,000$336,000 Dividends on preferred stock 180.000 90.000 Available for dividends $480,000$300,000$246,000 Shares of common stock ÷400.000÷200,000÷100.000 Earnings per share $1.20 $1.50 $246 c13-7
C13 - 7 Alternative Financing Plans – $800,000 Earnings Plan 1 Plan 2 Plan 3 12 % bonds — — $2,000,000 Preferred 9% stock, $50 par — $2,000,000 1,000,000 Common stock, $10 par $4,000,000 2,000,000 1,000,000 Total $4,000,000 $4,000,000 $4,000,000 Earnings before interest and income tax $ 800,000 $ 800,000 $ 800,000 Deduct interest on bonds — — 240,000 Income before income tax $ 800,000 $ 800,000 $ 560,000 Deduct income tax 320,000 320,000 224,000 Net income $ 480,000 $ 480,000 $ 336,000 Dividends on preferred stock — 180,000 90,000 Available for dividends $ 480,000 $ 300,000 $ 246,000 Shares of common stock 400,000 200,000 100,000 Earnings per share $ 1.20 $ 1.50 $ 2.46
Alternative Financing Plans-$440, 000 Earnings Plan 1 Plan 2 Plan 3 12 bonds $2,000,000 Preferred 9% stock, $50 par $2,000,0001,000,000 Common stock,$10par$4000,0002,000,0001,000,000 Total $4,000,000$4,000,000$4,000,000 Earnings before interest and income tax $440,000$440,000$440,000 Deduct interest on bonds 240,000 Income before income tax 440,000 440, 000 200,000 Deduct income tax 176000176,000 80.000 Net income $264,000$264,000$120,000 Dividends on preferred stock 180.000 90.000 Available for dividends $264,000$84,000$30,000 Shares of common stock ÷400.000÷200,000÷100.000 Earnings per share $0.66$0.42 $030 c13-8
C13 - 8 Alternative Financing Plans – $440,000 Earnings Plan 1 Plan 2 Plan 3 12 % bonds — — $2,000,000 Preferred 9% stock, $50 par — $2,000,000 1,000,000 Common stock, $10 par $4,000,000 2,000,000 1,000,000 Total $4,000,000 $4,000,000 $4,000,000 Earnings before interest and income tax $ 440,000 $ 440,000 $ 440,000 Deduct interest on bonds — — 240,000 Income before income tax $ 440,000 $ 440,000 $ 200,000 Deduct income tax 176,000 176,000 80,000 Net income $ 264,000 $ 264,000 $ 120,000 Dividends on preferred stock — 180,000 90,000 Available for dividends $ 264,000 $ 84,000 $ 30,000 Shares of common stock 400,000 200,000 100,000 Earnings per share $ 0.66 $ 0.42 $ 0.30
Characteristics of Bonds Payable Long-term debt -repayable 10, 20, or 30 years after date of issuance ssued in face(principal) amounts of $1,000, or multiples of $1,000. Contract interest rate is fixed for term (life)of the bond Face amount of bond repayable at maturity date c13-9
C13 - 9 Characteristics of Bonds Payable Long-term debt – repayable 10, 20, or 30 years after date of issuance. Issued in face (principal) amounts of $1,000, or multiples of $1,000. Contract interest rate is fixed for term (life) of the bond. Face amount of bond repayable at maturity date
Bond variables and constants 1. Constants-fixed by bond contract. a. Principal (face) amount. b,. Contract rate of interest C. Term(life)of the bond. 2. Variables -determined in the bond market. a. Market price of the bond b. Market(effective) interest rate. c13-10
C13 - 10 Bond Variables and Constants 1. Constants – fixed by bond contract. a. Principal (face) amount. b. Contract rate of interest. c. Term (life) of the bond. 2. Variables – determined in the bond market. a. Market price of the bond. b. Market (effective) interest rate