Chapter 14 - Earnings per share Flashcards
What is the basic calculation of EPS?
Earnings / number of ordinary shares
What are earnings?
profit for year available to ordinary shareholders
what is number of shares?
weighted average number of ordinary shares
How do we calculate the full market value issue?
use weighted average table
How do we calculate a bonus issue?
assume bonus shares issued with original shares, so in issue of whole of current year
How do we calculate a rights issue?
use weighted average table, with pre-issue shares adjusted for bonus element using rights issue bonus fraction
What is a bonus issue?
where a company issues free shares to existing shareholders in proportion to their existing holdings
What is the bonus fraction?
new number of shares / old number of shares
Why might a business decide to issue bonus issues?
to reduce share price to attract new investors
Is there an injection of capital with bonus issues?
no
How are bonus issues treated?
As if they have always been in issue
When would a business consider a rights issue?
when they want to raise new finance to invest in new projects
What is a rights issue?
when a business gives existing shareholder the right to buy shares in proportion to their existing shares
What is one difference between a rights issue and a full market issue?
full market issue dilutes the shareholding, but rights issue maintains their percentage holding in the business
How are rights issues encouraged to shareholders?
normally below market value
What is the rights issue calculation?
actual market price per share / theoretical ex-rights price (TERP)
What is the purpose of diluted earnings per share (DEPS)?
to show the potential impact on EPS of future share issues arising as a result of instruments in issue at the year-end.
What are diluting instruments that are considered?
Convertible bonds
Options
What is a share option?
gives the option holder the right to buy shares at a predetermined price at a future date.
What happens if the market value of the shares at the future date is below the option price?
holder will not exercise the option
What is the impact on earnings for convertible bonds?
notional interest saved (post-tax)
What is the impact on shares with convertible bonds?
assume maximum conversion
What are the steps to calculate the fully diluted EPS?
Step 1: calculate the Basic EPS first
Step 2: Adjust earnings and shares
Step 3: How will earnings change? (loan stock x interest rate x tax rate)
Step 4: How will the number of shares change?
Step 5: Calculation of Diluted EPS (earnings + answer to step 3 / full shares + increase of shares)
What impact do options on DEPS have on earnings?
No impact
What impact do options on DEPS have on shares?
number of shares increases by bonus element
What is the 3 step process to options?
Step 1: Number of options in existence (basic EPS)
Step 2: Number of full price shares purchased with cash from options
Step 3: Calculate the difference as the bonus issue/ free element
