Several investors are in the process of organizing a new company. The investors believe that P2,600,000 will be needed to finance the new company’s operation, and they are considering three methods of raising this amount of money. Method A: All P2,600,000 would be obtained through issue of common stock Method B: P 1,300,000 would be obtained through issue of common stock and the other P1,300,000 would be obtained through issue of P100 par value, 12% preferred stock. Method C: P 1,300,000 would be obtained through issue of common stock, and the other P 1,300,000 would be obtained through issue of bonds carrying an interest ate of 12%. The investors organizing the new company are confident that it can earn P520,000 each year before interest and taxes. The tax rate will be 30%. Required: 1. Assuming that the investors are correct in their earnings estimate, compute the net income that would go to the common stockholders under each of the three financing methods listed above. 2. Using the income data computed in(1) above, compute the return on common equity under each of the three methods 3. Why do methods B and C provide a greater return on common equity than does method A? Why does method C provide a greater return on common equity than method B
Several investors are in the process of organizing a new company. The investors believe that P2,600,000 will be needed to finance the new company’s operation, and they are considering three methods of raising this amount of money.
Method A: All P2,600,000 would be obtained through issue of common stock
Method B: P 1,300,000 would be obtained through issue of common stock and the other P1,300,000 would be obtained through issue of P100 par value, 12%
Method C: P 1,300,000 would be obtained through issue of common stock, and the other P 1,300,000 would be obtained through issue of bonds carrying an interest ate of 12%. The investors organizing the new company are confident that it can earn P520,000 each year before interest and taxes. The tax rate will be 30%.
Required:
1. Assuming that the investors are correct in their earnings estimate, compute the net income that would go to the common stockholders under each of the three financing methods listed above.
2. Using the income data computed in(1) above, compute the
3. Why do methods B and C provide a greater return on common equity than does method A? Why does method C provide a greater return on common equity than method B?
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