G,H describe how earnings per share is calculated and calculate and interpret a company’s earnings per share (both basic and diluted earnings per share) for both simple and complex capital structures; distinguish between dilutive and antidilutive securities, and describe the implications of each for Flashcards
Describe how earnings per share is calculated and calculate and interpret a company's earnings per share (both basic and diluted earnings per share) for both simple and complex capital structures. Distinguish between dilutive and antidilutive securities, and describe the implications of each for the EPS calc
Earnings Per Share
A profitability performance measure for publically traded firms (not private)
Capital structures (simple, complex)
Simple - no potentially dilutive shares. Only common stock, nonconvertible debt, nonconvertible preferred stock
Complex - Contains potentially dilutive securities: options, warrants, convertible securities (complex report basic and diluted)
Simple structure - basic EPS
Basic EPS = NI - preferred Div/Weighted Avg. # common shares outstanding
EPS refers to ‘per-share earnings available to common shareholders’ (which looks like NI-prefferred DIV)
NI-preff. Div: Inc available to common stockholders
*Com. stock div NOT subtracted from NI because common stock DIVs a PART of NI available to common shareholders (in RE)
Weighted Avg # Shares
shares outstanding during the year, weighted by the portion of the year they were OUTSTANDING!!!
Weighted average shares and basic EPS
shares outstanding (T) + #shares outstanding (T) / (T)
NI - Pref. Div. payment / WA#shares outstanding
Stock Dividend
A distribution of additional shares to each shareholder in an amuont proportional to their current number of shares. Ex: If 10% div is paid, then holder 100 shares of stock would receive ‘10 additional shares’
Stock Split
The division of each ‘old’ share into a specific number of ‘new’ (post-split) shares. The holder of 100 shares will have 200 shares after a 2-for-1 split to 150 shares after a 3-for-2 split.
2-for-1 split = x2 = 100% stock dividend
3-for-2 split =x1.5=50% stock dividend
Effect of a stock div. or split on the weighted average number of common shares
Basic diluted
Outstanding(1.[%div, split]) = adjusted
Adjusted ( months outstanding) = Share/month
Total share month / 12 = avg shares
Compute basic EPS = $3.76 eps or NI available to share holders
Things to know about WA#shares outstanding Calc
Weight: Days OUTSTANDING/ DAYS IN YEAR (exam uses monthly approximation)
Shares issued enter from issuance date
Exclude reacquired shares at the date of reacquisition
Include shares sold or issued in a purchase of assets from issuance date
Adjust stock splits, divs, to all shares outstanding prior to the split,div, and to the beg-of-period Weighted Average Shares. **Do not adjust shares issued or repurchased after the split or dividend.
Dilute
To make a liquid thinner or weaker by the addition of water or the like
Dilutive Securities Basics to Understanding
Dilutive v. Antidilutive
Dilutive securities are options, warrants, convertible debt, or convertible preferred stock that would decrease EPS if exercised or converted to common stock.
Exercise = conversion to common stock
Anti - all that that would INCREASE EPS if exercised or converted to common stock
Dilutive decreases EPS
Antidilutive increases EPS
‘Income available to common shareholders’ aka
NI - preff. Div’s
Diluted EPS (contains diluted securities)(diluted securities = options, warrants, convertible debt, convertible proeff. stock that decreases EPS if exercises [ converted to common stock ] )
Diluted securities? Adjust numerator as follows
when
Convertible preff. stock is dilutive (EPS will fall if converted to common stock): The convertible preferred dividends must be added to earnings available to common shareholders
Convertible bonds = dilutive: then the bonds’ after-tax interest expense is not considered an interest expense for diluted EPS. Hence, interest expense multiplied by (1 - the tax rate) must be added back to the numerator.
Dilutive Stock Options or Warrants (only dilutive when exercise price<avg. market price of the stock over the year)
These Inc. the number of common shares outstanding in the denominator for diluted EPS. There no NO ADJUSTMENT TO THE NUMERATOR.
If options or warrants are dilutive (avg. market stock price>exercise price) use TREASURY STOCK METHOD to calc. # of shares used in the denominator
Assumption: Funds recieved by the company from the exercise of the options would be sued to hypothetically purchases shares of the company’s common stock in the market at the average market price.
The net increase in the number of shares outstanding (the adjustment to the denominator) is the number of shares created by exercising the options less the number of shares hypothetically repurchased with the proceeds of exercise.
Treasury Stock Method Calc
5000 shares outstanding all year
2000 outstanding WARRANTS all year CONVERTIBLE to one share each at $20/share
Year end Pbaxter stock = $40
Avg stock price = $30
What effect will these warrants have on the WA#shares outstanding?
Treasury Stock Method Assumption: that the company uses these funds to repurchase shares at the average market price
Repurchase = 40,000 = (2000 outstanding warrants) (convertible to 1 share each at $20) / avg. stock market price $30 = 1,333 shares at avg. market price upon exercise = 667 net shares issued rather = 2000 outstanding warrants all year - 1333 shares at market price.
Diluted EPS Equation
Adjusted income available for common share holders / Weighted avg. common and potential common shares outstanding
Adjusted income avaialb efor common share holders [ NI - preff. div +convertible preff div + convertible debt int. (1-t)] / [WA#shares+#shares conv. pfd. shares + #convertible debt shares + #issuable stock option shares]
Looks overwhelming but…each potentially dilutive security must be examined seperately to detmine if it is actually dilutive (will reduce EPS if converted to common stock)
Dilutive: Determine if it’s actually ‘dilutive’
examine seperately, find whether it WILL REDUCE EPS IF CONVERTED TO COMMON STOCK
EPS with convertible debt
v. Basic EPS : Effects of conversion should (# Per Share AMOUNT TO DILUTE!!
Convertible Debt to Common Stock: Basic EPS>Diluted EPS. If so TREAT AS COMMON STOCK IN COMPUTING DILUTED EPS. If Diluted EPS>Basic EPS, then Antidilutive
Quick way (to determine whether convertible debt is dilutive)
Calc ‘per share impact’: Convertible debt interest (1-t) / Convertible Debt Shares = #>Basic EPS [’#’ means per share amount], antidilutive. If Basic EPS>#: per share amount = dilutive
EPS with stock options
NI - preff. div (#shares at par x .r) / #shares outstanding + Net inc. in common shares
Quick Net inc. common shares calc: Avg market price - Exercise price / AMP (#of common shares options and warrants can be converted into)
EPS with Convertible preferred stock
Quick convertible prefferred stock dilution check
Preferred div/#shares that will be created if the preferred stock is converted
$par value shares (.div)/#convertible shares
100(.1)/40 = .25
.25 convertible preferred
EPS with convertible bonds, convertible preferred, and options
Calc all things as held separately
Step 1: Basic EPS
Step 2: # shares created (increase in common stock outstanding if converted,exercised)
Convertible preff –> Common stock: (issued)(to convertible)
Convertible Bonds –> Common stock: (Outstanding, issues)(Convertible)
Exercise Options –> [AMP - EP / AMP] (Convertible)
Step 3: Numerator : Rev. adjustments to NI
Convertible Preff: (preff. issues)($par preff)(%preff)
Convertible Bonds: (issues)($parBonds)(%bonds) (1-tax rate) = Increase in Income
Exercise Options:
Step 4: Compute Diluted EPS
NI-preff. div + conv. pref. shares + Conv. bonds/outstanding + conv. preff + convert bonds + exercising options
Diluted EPS comp < Basic EPS
Ok to convert. Dilute!
NI to common
Net income less preferred dividends
