2.3 Per-Share Ratios Flashcards
Formula for Earnings Per-Share (EPS)
EPS = Net income available to common shareholders / weighted average common shares outstanding
- Net income available to common shareholders = income - preferred dividends
For the year ended May 31, Year 2, the company had per-share earnings of $4.80. The company’s outstanding stock for the Year 1-Year 2 fiscal year consisted of $2,000,000 of 10% preferred with $100 par value and 1,000,000 shares of common. On June 1, Year 2, the common stock split 3 for 1, and the company redeemed one-half of the preferred stock at par value. The company’s net income for the year ended May 31, Year 3, was 10% higher than in Year 2. Earnings per share in Year 3 on the company’s common stock was
A. $1.76
B. $1.80
C. $5.28
D. $5.40
B. $1.80
Year 2:
* 1,000,000 common shares x $4.80 = $4,800,000 net income available to common shareholders
* Dividends to preferred shareholders = $2,000,000 x 10% = $200,000
* Net income - $4,800,000 + $200,000 = $5,000,000
Year3:
* Net income = $5,000,000 Y2 net income x 1.10 = $5,500,000
* Dividends to preferred shareholders = now only $1,000,000 PS (half redeemed) x 10% = $100,000
* Common shares outstanding (3 for 1 stock split) = 1,000,000 x 3 = 3,000,000
* EPS = Net income available to common shareholders / weighted average common shares outstanding
= ($5,500,000 - 100,000) / 3,000,000 shares = $1.80 per share
A company had 150,000 shares outstanding on January 1. On March 1, 75,000 additional shares were issued through a stock dividend. Then on November 1, the company issued 60,000 shares for cash. The number of shares to be used in the denominator of the EPS calculation for the year is
A. 222,500 shares.
B. 225,000 shares.
C. 235,000 shares.
D. 285,000 shares.
C. 235,000 shares.
The weighted average number of common shares outstanding during the year is the EPS denominator. Shares issued in a stock dividend are assumed to have been outstanding as of the beginning of the earliest accounting period presented. Thus, the 75,000 shares issued on March 1 are deemed to have been outstanding on January 1. The EPS denominator equals 235,000 shares {[150,000 x (12 months / 12 months)] + [75,000 x (12 months / 12months)] +[60,000 x (2 months / 12months)]}.
A company has 100,000 outstanding common shares with a market value of $20 per share. Dividends of $2 per share were paid in the current year and the company has a dividend payout ratio of 40%. The price-earnings ratio of the company is
A. 2.5
B. 4
C. 10
D. 50
B. 4
The P/E ratio equals the share price divided by EPS. If the dividends per share equaled $2 and the dividend-payout ratio was 40%, EPS must have been $5 ($2 / 0.4). Accordingly, the P/E ratio is 4 ($20 share price / $5 EPS)
A corporation had 40,000 shares of common stock outstanding on November 30, Year 1. On May 20, Year 2, a 10% stock dividend was declared and distributed. On June 1, Year 2, options were issued to its existing stockholders giving them the immediate right to acquire one additional share of stock for each share of stock held. The option price of the additional share was $6 per share, and no options have been exercised as of year end. The average price of common stock for the year was $20 per share. The price of the stock as of November 30, Year 2, the end of the fiscal year, was $30 per share, and the corporation’s net income for the fiscal year was $229,680. The corporation had no outstanding debt during the year, and its tax rate was 30%. The basic earnings per share (rounded to the nearest cent) of common stock for the fiscal year ended November 30, Year 2, was
A. $5.22 per share.
B. $3.82 per share.
C. $5.74 per share.
D. $3.38 per share.
A. $5.22 per share
BEPS is net income available to common shareholders divided by the weighted average number of common shares outstanding during the year. The denominator will include the 40,000 shares already outstanding plus the 4,000-share stock dividend (stock dividends and stock splits are deemed to have occurred at the beginning of the earliest period presented). Thus, 44,000 shares are considered to have been outstanding throughout the year. The stock options have no effect on the weighted-average shares outstanding because they were not exercised in the current period. BEPS is $5.22 ($229,680 ÷ 44,000).
In calculating diluted earnings per share when a company has convertible bonds outstanding, the number of common shares outstanding must be List A to adjust for the conversion feature of the bonds, and the net income must be List B by the amount of interest expense on the bonds, net of tax.
List A, List B
A. Increased, Increased
B. Increased, Decreased
C. Decreased, Increased
D. Decreased, Decreased
A. Increased, Increased
The weighted-average number of shares outstanding must be increased to reflect the shares into which the bonds could be converted. Also, the effect of the bond interest on net income must be eliminated. In this way, earnings per share is calculated as if the bonds had been converted into common shares as of the start of the year.
The equity section of a Statement of Financial Position is presented below.
Preferred stock, $100 par $12,000,000
Common stock, $5 par 10,000,000
Additional paid-in capital – common stock 18,000,000
Retained earnings 9,000,000
Net worth $49,000,000
The book value per share of common stock is
A. $18.50
B. $5.00
C. $14.00
D. $100
A. $18.50
The book value per common share = net assets (equity) attributable to common share holders / common shares outstanding
= [($10,000,000 common stock + $18,000,000 additional paid-in capital + $9,000,000 RE) / ($10,000,000 / $5 par)] = 18.50
A company paid out one-half of last year’s earnings in dividends. Earnings increased by 20%, and the amount of its dividends increased by 15% in the current year. The company’s dividend payout ratio for the current year was
A. 50%
B. 57.5%
C. 47.9%
D. 78%
C. 47.9%
The prior-year dividend payout ratio was 50%. Hence, if prior-year net income was X, the total dividend payout would have been 50%. If earnings increase by 20%, current-year income will be 120%X. If dividends increase by 15%, the total dividends paid out will be 57.5%X (115% x 50%X), and the new dividend payout ratio will be 47.9% (57.5%X / 120%X).
A corporation computed the following items from its financial records for the year:
Price-earnings ratio 12
Payout ratio .6
Asset turnover ratio .9
The dividend yield on common stock is
A. 5.0%
B. 7.2%
C. 7.5%
D. 10.8%
A. 5.0%
Dividend yield is computed by dividing the dividend per share by the market price per share. The payout ratio (.6) is computed by dividing dividends by net income per share (EPS). The P/E ratio (12) is computed by dividing the market price per share by net income per share. Thus, assuming that net income per share (EPS) is $X, the market price must be $12X and the dividends per share $.6X (.6 × $X net income per share). Consequently, the dividend yield is 5.0% ($.6X dividend ÷ $12X market price per share).
The Dawson Corporation projects the following for the year:
Earnings before interest and taxes $35 million
Interest expense $5 million
Preferred stock dividends $4 million
Common stock dividend-payout ratio 30%
Common shares outstanding 2 million
Effective corporate income tax rate 40%
The expected common stock dividend per share for Dawson Corporation is
A. $2.34
B. $2.70
C. $1.80
D. $2.10
D. $2.10
- Calculate net income = (EBIT - interest) x (1-tax rate)
- Subtract preferred dividends to calculate earnings available to common shareholder
(Net income - preferred dividends) - Calculate EPS
= (earnings available to common shareholder/common shares) - Multiply dividend-payout ratio
The company’s net income is $18,000,000 ($35,000,000 EBIT - $5,000,000 interest) x (1.0 - .4 tax rate). Thus, the earnings available to common shareholder equals $14,000,000 ($18,000,000 - $4,000,000 preferred dividends), and EPS is $7 ($14,000,000 / $2,000,000 common shares). Given a dividend-payout ratio of 30%, the dividend to common shareholders is expected to be $2.10 per share ($7 x 30%).
The Dawson Corporation projects the following for the year:
Earnings before interest and taxes $35 million
Interest expense $5 million
Preferred stock dividends $4 million
Common stock dividend-payout ratio 30%
Common shares outstanding 2 million
Effective corporate income tax rate 40%
If Dawson Corporation’s common stock is expected to trade at a price-earnings ratio of 8, the market price per share (to the nearest dollar) would be
A. $104
B. $56
C. $72
D. $68
B. $56
Net income is $18,000,000 [35,000.000 EBIT-5,000,000 interest x (1 - 0.4 tax rate)], and EPS is $7 [($18,000,000 NI - $4,000,000 preferred dividends) / 2,000,000 common shares]. Consequently, the market price is $56 ($7 EPS x 8 P/E ratio).
A company’s convertible debt securities are both a potential common stock and dilutive in determining earnings per share. What would be the effect of these securities on the calculation of basic earnings per share (BEPS) and dilutive earnings per share (DEPS)?
BEPS, DEPS
A. Increase, No effect
B. Decrease, Increase
C. No effect, Decrease
D. Decrease, Decrease
C. No effect, Decrease
Securities classified as potential common stock should be included in the computation of the number of common shares outstanding for DEPS if the effect of the inclusion is dilutive. Dilutive potential common stock decreases DEPS. BEPS is not affected by potential common stock.
A publicly traded corporation in an industry with an average price-earnings ratio of 20 has the following summary financial results.
Sales: $1,000,000
Expenses: 500,000
Operating income: $500,000
Taxes: 300,000
Net income: 200,000
Assets: 2,500,000
Liabilities: 1,000,000
Shareholder’s equity: 1,500,000
A competitor wishes to make a bid to acquire the stock of the company. What is the current market value?
A. $10,000,000
B. $4,000,000
C. $1,500,000
D. $20,000,000
B. $4,000,000
The price-earnings ratio is express as the market price per share divided by the earnings per share.
However, this can also be expressed as the total market price over the total earnings.
Earnings (net income) are equal to $200,000 and the price-earnings ratio is equal to 20. Therefore, the market value can be solved for as follows:
20 = market value / 200,000
market value = 20 x $200,000
=$4,000,000
Selected year-end information from the balance sheet of a publicly-traded company as of December 31, Year 1, follows.
Common stock (par value $1 per share) $1,000,000
Additional paid-in capital 2,000,000
Retained earnings 500,000
Year 2 is nearly over and it is expected that net income will be $200,000, the dividend payout ratio will be 30%, and there will be no shares issued or redeemed during the year. If comparable firms are trading at a market to book ratio of two times, what is the expected market price per share at the end of Year 2?
A. $7.28
B. $7.40
C. $6.28
D. $7.00
A. $7.28
The first step is to find the expected book value per share at the end of Year 2.
There are 1,000,000 shares outstanding ($1,000,000 / $1 par value). If the company has income of $200,000, of which 30% is paid out as dividends, then retained earnings will increase by $140,000 (70% x $200,000). Therefore, the new total for retained earnings will be $640,000. Thus, total equity becomes $3,640,000, or $3.64 per share. If the price to book ratio is 2, book value of $3.64 is multiplied by 2 for a share price of $7.28.
A company’s financial data for the recent fiscal year follows.
Common stock 5,000,000 shares outstanding
Preferred stock 1,000,000 shares
Net income $50,000,000
Common stock dividends $8,000,000
Preferred stock dividends $2,000,000
The company would have reported basic and diluted earnings per share of
A. $10.00 and $9.60, respectively.
B. $9.60 and $9.60, respectively.
C. $10.00 and $6.67, respectively.
D. $9.60 and $8.00, respectively.
B. $9.60 and $9.60, respectively.
Basic earnings per share (EPS) = Income available to common shareholders / Weighted-average shares outstanding.
The income available to common shareholders = net income - preferred dividends.
Note that common dividends are not subtracted because they represent income that is available to common shareholders. Accordingly, the income available to common shareholders is $48,000,000 ($50,000,000 - $2,000,000). The weighted-average shares outstanding are given as 5,000,000 shares. Thus, the basic EPS is $9.60 ($48,000,000 / 5,000,000). Furthermore, there is no mention of security that could potentially dilute EPS; thus, the diluted EPS also equals $9.69.
