Income Statement :- EPS Flashcards
Potentially Dilutive Securities
These securities include stock options,warrants,convertible debt and convertible preferred stock
Dilutive Securities
Those securities that would decrease EPS if exercised and converted to common stock
Antidilutive Securities
Those securities that would increase EPS if exercised and converted to common stock
Simple Capital Structure
A capital structure that contains no potentially dilutive securities. This structure contains only common stock,non convertible debt and non convertible preferred stock
Complex Capital Structure
Complex Structure contain potentially dilutive securities such as options,warrants or convertible securities
Weighted Average No of Shares Out Standing
Each share issue is weighted by the portion of the year it was outstanding . Stock splits and stock dividends are applied retroactively to the beginning of the year so old share are converted to new shares for consistency
Dilutive EPS :- Convertible Debt
Dilutive EPS :- Convertible Debt
Dilutive EPS :- Convertible Debt
Dilutive EPS :- Stock Option
Diluted EPS
= Net Income - Preferred Dividend
/
Weighted Average Shares + Shares Issuable from Stock Options
Dilutive EPS :- Stock Option Question
Dilutive EPS :- Stock Option Question
Treasury Stock Method
Options and warrants are dilutive whenever the exercise price is less than the average stock price over the reporting period
The treasury stock method assumes that the hypothetical funds received by the company from the exercise of options or warrants are used to purchase shares of the company’s common stock at the average market price over the reporting period
Treasury Stock Method :- Example
Stock Options
Diluted EPS= Net Income - Preferred Dividend/ Weighted Average Shares + Shares Issuable from Stock Options
Stock Options
Convertible Preferred Stock
Convertible Preferred Stock Question
Convertible Preferred Stock Question
During 2004, Covax Corp. reported net income of $2.4 million and 2 million shares of common stock. Covax paid cash dividends of $14,000 to its preferred shareholders and $30,000 to its common shareholders. In 2004, Covax issued 900, $1,000 par, 5.5 percent bonds for $900,000. Each bond is convertible to 50 shares of common stock. Assume the tax rate is 40%. Compute Covax’s basic and diluted EPS.
Basic EPS Diluted EPS
$1.19 $1.18
$1.19 $1.22
$1.22 $1.22
2004 Basic EPS: 2,400,000-14000/2000000 = 1.19
2004 Diluted EPS: 2,400,000-14000 + 49500 (1-0.4) divided by 2,000,000 + 45000 = 1.18
Selected information from Able Company’s financial activities is as follows:
Net Income was $720,000.
1,000,000 shares of common stock were outstanding on January 1.
1,000 shares of 8%, $1,000 par value preferred shares were outstanding on January 1.
The tax rate was 40%.
The average market price per share for the year was $20.
6,000 shares of 3%, $500 par value preferred shares, convertible into common shares at a rate of 40 common shares for each preferred share, were outstanding for the entire year.
Able’s basic and diluted earnings per share (EPS) are closest to:
Basic EPS Diluted EPS
$0.55 $0.55
$0.55 $0.52
$0.64 $0.64
Able’s basic earnings per share ((Net Income − Preferred Stock Dividends) / weighted average shares outstanding) for 2004 was [($720,000 − ($500 × 6,000 × 0.03) − ($1,000 × 1,000 × 0.08)] / 1,000,000 = $0.55. If the convertible preferred were converted to common stock on January 1, 6,000 × 40 = 240,000 additional shares would have been issued. Also, dividends on the convertible preferred would not have been paid.
So diluted EPS was ($720,000 − 80,000) / (1,000,000 + 240,000) = $0.52.
Lawson, Inc.’s net income for the year was $1,060,000 with 420,000 shares outstanding. Lawson has 2,000 shares of 8%, $1,000 par value convertible preferred stock that were outstanding the entire year. Each share of preferred is convertible into 50 shares of common stock. Lawson’s diluted earnings per share are closest to:
A)$2.04.
B)$1.94.
C)$2.14.
Lawson’s basic EPS ((net income – preferred dividends) / weighted average common shares outstanding) is ($1,060,000 – (2,000 × $1,000 × 0.08)) / 420,000 = $2.14. To calculate diluted EPS the convertible preferred shares are presumed to have been converted, the preferred dividends paid are added back to the numerator of the EPS equation, and the additional common shares are added to the denominator of the equation. Lawson’s diluted EPS is $1,060,000 / (420,000 + 100,000) = $2.04.
The equation for Basic EPS (net income – preferred dividends / weighted average number of common shares outstanding) does not include the number of preferred shares outstanding, because the objective is to determine the earnings available to the common shareholder.
For an organization with a simple capital structure, the computation of earnings per share is least likely to consider:
A)net income.
B)the weighted average number of common shares outstanding.
C)the weighted average number of preferred shares outstanding.
The equation for Basic EPS (net income – preferred dividends / weighted average number of common shares outstanding) does not include the number of preferred shares outstanding, because the objective is to determine the earnings available to the common shareholder.
Savannah Corp.’s financial accounts for the year ended December 31 included the following information:
Net Income: $122,000
Preferred Stock Dividends Paid: $35,000
Common Stock Dividends Paid: $42,000
Common Shares outstanding at January 1: 50,000
10% preferred $100 par value shares outstanding at January 1: 3,500
No stock transactions occurred during the year and all preferred stock dividends were paid. Basic earnings per share for Savannah are closest to:
A)$0.90.
B)$2.44.
C)$1.74.
Savannah Corp.’s basic EPS ((net income – preferred dividends) / weighted average number of common shares outstanding) was (($122,000 − $35,000) / $50,000 =) $1.74.
Oregon Corp.’s stock transactions during the year were as follows:
January 1: 320,000 shares outstanding.
April 1: 1-for-2 reverse stock split occurred.
July 1: Acquisition of Smith, Inc. in exchange for issuance of 60,000 shares.
October 1: 30,000 shares issued for cash.
What is Oregon’s weighted average number of shares outstanding?
A)167,500.
B)250,000.
C)197,500.
The January 1 balance is adjusted retroactively for the reverse stock split and 320,000 / 2 = 160,000 shares are treated as outstanding from January 1. Issuance of stock is included from the date of issuance. The weighted average shares are computed by multiplying the share amounts by the number of months the shares were outstanding, then adding these amounts and dividing the sum by 12.
January 1:initial shares
160,000 × 12 =1,920,000
July 1:Smith acquisition
60,000 × 6 =360,000
October 1:cash issuance 30,000 × 3 =90,000
Total:2,370,000
Oregon’s weighted average shares = 2,370,000 / 12 = 197,500.
Sampson Corp. had 500,000 shares of common stock outstanding at the beginning of the year. The average market price was $20.
On April 1, Sampson issued 100,000 shares of $1000 par value 10 percent preferred stock.
On July 1, Sampson issued 200,000 warrants to purchase 10 shares of common stock each at $22 per share.
On October 1, Sampson repurchased 60,000 of common stock as treasury stock for $15 per share.
The weighted average common shares outstanding Sampson should use to compute basic earnings per share (EPS) was:
A)515,000.
B)485,000.
C)600,000.
Oregon’s weighted average shares = 2,370,000 / 12 = 197,500.
Only the October 1 transaction affects the weighted average common shares outstanding because the April 1 transaction would not affect the number of shares outstanding and the July 1 transaction involves warrants which would not be included in the basic EPS calculation. The computation for basic EPS is [(500,000 × 12) − (60,000 × 3)] / 12 = 485,000.
Which of the following securities would least likely be found in a simple capital structure?
A)6%, $5000 par value putable bond.
B)3%, $100 par value convertible preferred.
C)7%, $100 par value non convertible preferred.
A simple capital structure contains no potentially dilutive securities such as stock options, warrants, or convertible preferred stock.
A complex capital structure, for purposes of determining disclosure of diluted Earnings Per Share, is distinguished from a simple capital structure by the:
A)company’s use of debt to finance its operations.
B)company having issued warrants, convertible securities, or options.
C)company having preferred stock outstanding.
A complex structure contains potentially dilutive securities such as options warrants or convertible securities. Where as simple capital structures contain no potentially dilutive securities and contains only common stock and non-convertible securities.
Bluff, Inc.’s stock transactions during the year were as follows:
January 1 90,000 common shares outstanding.
April 1 20% stock dividend is declared and issued.
October 1 10,000 shares are reacquired as treasury stock.
What is Bluff’s weighted average number of shares outstanding during the year?
A)105,500.
B)98,000.
C)101,000.
Initial shares: 90,000 × 1.20 =108,000
Reacquired treasury shares: 10,000 × 3/12 = –2,500
Total = 105,500
Juniper Corp’s stock transactions during the year 20X4 were as follows:
January 1 540,000 shares issued and outstanding
March 1 50 percent stock dividend
July 1 180,000 treasury shares reacquired
October 1 60,000 treasury shares reissued
When computing for earnings per share (EPS) computation purposes, what was Juniper’s weighted average number of shares outstanding during 20X4?
A)735,000.
B)930,000.
C)870,000.
Which type of a capital structure contains no dilutive securities?
A)Basic.
B)Simple.
C)Complex.
A simple capital structure contains no potentially dilutive securities such as stock options, warrants, or convertible preferred stock.
A)
A firm with a capital structure consisting of only common stock and non-convertible bonds is said to have a:
A)non-diluted capital structure.
B)simple capital structure.
C)straight capital structure.
A complex structure contains potentially dilutive securities such as options warrants or convertible securities. Where as simple capital structures contain no potentially dilutive securities and contains only common stock and non-convertible securities.
A complex capital structure would typically contain:
A)convertible bonds.
B)variable rate notes.
C)bank notes.
A complex structure contains potentially dilutive securities such as options warrants or convertible securities.
Where as simple capital structures contain no potentially dilutive securities and contains only common stock and non-convertible securities.
The SSP Company had 5 million shares outstanding on January 1. On February 15 the board of directors approved a 3:2 stock split, effective April 1. What is the weighted average number of shares outstanding for the SSP Company for year-end?
A)6,875,000 shares.
B)5,625,000 shares.
C)7,500,000 shares.
Stock splits and stock dividends are applied to all shares that existed at the beginning of the period and shares that were issued or repurchased during the period, but prior to the split or dividend. For SSP, the 5 million beginning-of-year shares outstanding are adjusted to 7.5 million shares (5.0 × 3/2) as a result of the 3:2 split
A firm has had the following numbers of shares outstanding during the year:
Beginning of year 10,000,000 shares
Issued on April 1 500,000 shares
Split 2 for 1 on July 1
Issued on October 1 100,000 shares
Split 2 for 1 on December 31
Based on this information, what is the weighted number of shares outstanding for the year?
A)42,400,000.
B)41,550,000.
C)20,780,000.
Outstanding all year 10,000,000 × 2 × 2 × 1= 40,000,000
Outstanding for 0.75 years=500,000 × 2 × 2 × 0.75=1,500,000
Outstanding for 0.25 years 100,000 × 2 × 0.25= 50,000
Weighted average number of shares for year: =41,550,000
A firm had the following numbers of shares outstanding during the year:
Beginning of year 8,000,000 shares
Issued on April 1 750,000 shares
Paid stock divided of 20% on July 1
Issued on October 1
100,000 shares
Purchased Treasury stock November 1 1,000,000 shares
Split 2 for 1 on December 31
Based on this information, what is the weighted number of shares outstanding for the year?
A) 20,266,667.
B) 20,783,333.
C)42,444,444.
Outstanding all year
8,000,000 × 1.2 × 2 × 1.0=19,200,000
Outstanding for 0.75 years=750,000 × 1.2 × 2 × 0.75
1,350,000
Outstanding for 0.25 years =100,000 × 2 × 0.25
= 50,000
Retired for 2 months=-1,000,000 × 2 × (2/12)
–333,333
Weighted average number of shares for year:
20,266,667
A firm had the following numbers of shares outstanding during the year:
Beginning of year 8,000,000 shares
Issued on April 1 750,000 shares
Paid stock divided of 20% on July 1
Issued on October 1 100,000 shares
Purchased Treasury stock November 1 1,000,000 shares
Split 2 for 1 on December 31
Based on this information, what is the weighted number of shares outstanding for the year?
A)20,266,667.
B)20,783,333.
C)42,444,444.
Outstanding all year
8,000,000 × 1.2 × 2 × 1.0 =19,200,000
Outstanding for 0.75 years =750,000 × 1.2 × 2 × 0.75
1,350,000 =Outstanding for 0.25 years
100,000 × 2 × 0.25 =50,000
Retired for 2 months =-1,000,000 × 2 × (2/12)= –333,333
Weighted average number of shares for year:
20,266,667
Zimmer Co. had the following common shares outstanding:
January 1, 2003: 50,000
October 1, 2003: Issued 20,000 shares
March 1, 2004: Issued a 10% stock dividend
July 1, 2004: Declared a 2 for 1 stock split
October 1, 2004: Repurchased 30,000 shares
Calculate the weighted average number of common shares outstanding for 2003 and 2004.
2003 2004
A) 55,000 124,500
B)55,000 146,500
C)10,000 124,000
For year 2003:
50,000 × 12 = 600,000
20,000 × 3 = 60,000
660,000/12 = 55,000
For year 2004:
70,000 × 1.1 × 2 = 154,000 × 12 = 1,848,000
(30,000) × 3 = (90,000)
1,758,000 / 12 = 146,500
At the beginning of this year Aristotle Co. had 400,000 shares of common stock outstanding. During the year, Aristotle paid a 10 percent stock dividend on May 31, issued 90,000 new common shares on June 30, and repurchased 12,000 shares on December 1. The number of shares Aristotle should use in computing earnings per share at the end of the year is:
A)475,000.
B)476,000.
C)484,000.
[400,000 shares × 12 months + 40,000 × 12 months + 90,000 × 6 months - (12,000 × 1 months)] divided by 12 = 484,000 shares
Robinson Company had 1 million shares outstanding at the beginning of the year. On April 1, Robinson issued an additional 300,000 shares. On July 1, Robinson issued 200,000 more shares. What is Robinson’s weighted average number of shares outstanding for the calculation of earnings per share?
A)1,325,000 shares.
B)1,500,000 shares.
C)1,200,000 shares.
Weighted average shares = 1,000,000 + (0.75) 300,000 + (0.5) 200,000 = 1,325,000 shares
At the beginning of 2004, Osami Corporation had 1.4 million shares of common stock outstanding and no preferred stock. At the end of August 2004, Osami issued 1.2 million new shares of common stock. If Osami reported net income equal to $7.2 million, what were its earnings per share (EPS) for 2004?
A)$4.00.
B)$3.33.
C)$2.77.
The new shares were only outstanding 4 months of the year. Thus, the weighted average number of shares outstanding is [1.4 + (4/12)(1.2)] million = 1.8 million shares. So basic EPS = $7.2 million / 1.8 million = $4.00.
The following information pertains the QRK Company:
One million shares of common stock outstanding at the beginning of 2005.
200,000 shares issued on the last day of March.
500,000 shares issued on the last day of June.
800,000 shares issued on the last day of September.
What is the number of shares that should be used to compute 2005 earnings per share for the QRK Company?
A)1.6 million.
B)2.5 million.
C)1.9 million.
The weighted average number of common shares outstanding is the number of shares outstanding during the year weighted by the portion of the year they were outstanding. For the QRK Company, the weighted number of shares outstanding is the original one million shares plus 150,000 shares for the end-of-March issue (= 200,000 × 9/12), plus 250,000 shares for the end-of-June issue (= 500,000 × 6/12), plus 200,000 shares for the end-of-September issue (= 800,000 × 3/12), or 1.6 million shares.
The ZZT Company went public on June 1, 2004, by issuing 25 million shares of common stock. In 2005, the firm raised additional capital by issuing 2 million shares of preferred stock. What is the weighted average number of common shares outstanding for the year ending December 31, 2005?
A)25,000,000.
B)14,583,333.
C)10,416,667.
The weighted average number of common shares outstanding is the number of shares outstanding during the year weighted by the portion of the year they were outstanding. Since no new common shares were issued in 2005, and there were 25 million shares at the end of 2004, there are 25 million shares at the end of 2005. Note that the preferred stock shares do not affect the common shares outstanding.
A simple capital structure is least likely to include:
A)convertible bonds.
B)treasury stock.
C)callable preferred stock.
Simple capital structures do not include any potentially dilutive securities (a security that could decrease earnings per share if exercised). Convertible bonds are potentially dilutive.
Ajax Company has a simple capital structure. Which of the following will NOT be found on its balance sheet?
A)3%, $100 par value convertible bond.
B)6%, $50 par value callable bond.
C)10%, secured mortgage bond denominated in Swiss francs.
If convertible bonds exist, the firm has a complex capital structure
An analyst has gathered the following information about a company:
110,000 shares of common outstanding at the beginning of the year.
The company repurchases 20,000 of its own common shares on July 1.
Net income is $300,000 for the year.
10,000 shares of existing 10 percent cumulative $100 par preferred outstanding that is not in arrears at the beginning or ending of the year.
The company also has $1 million in 10 percent callable bonds outstanding.
The company has declared a $0.50 dividend on the common.
What is the company’s basic Earnings Per Share?
A)$3.00.
B)$1.00.
C)$2.00.
Interest is already deducted from earnings.
The following information pertains to Bender, Inc., for last year:
Net income of $25 million.
1 million shares of $10 par value preferred stock outstanding paying a 10% dividend.
50 million shares of common stock outstanding at the beginning of the year.
Issued an additional 5 million shares of common stock on 7/1.
What is Bender, Inc.’s basic earnings per share (EPS)?
A)$0.476.
B)$0.384.
C)$0.457.
50,000,000 common shares × 12 months = 600,000,000
5,000,000 common shares × 6 months = 30,000,000 = 630,000,000
630,000,000 / 12 = 52,500,000 average shares
[$25,000,000(NI) − $1,000,000(preferred dividends)] / 52,500,000 shares = $24,000,000 / 52,5000,000 = $0.457
The standard equation for computing basic earnings per share (EPS) is:
A)[Net Income − Common Dividends] / Weighted Average Number of Common Shares Outstanding.
B)[Net Income – Preferred Dividends] / Weighted Average Number of Common Shares Outstanding.
C)[Sales − Cost of Goods Sold] / Number of Preferred Shares Outstanding.
The basic EPS calculation does not consider the effects of any dilutive securities in the computation.
Basic EPS = [Net Income – Preferred Dividends]
/
Weighted Average Number of Common Shares Outstanding
Connecticut, Inc.’s stock transactions during the year 20X5 were as follows:
January 1: 360,000 common shares outstanding.
April 1: 1 for 3 reverse stock split.
July 1: 60,000 common shares issued.
When computing for earnings per share (EPS) computation purposes, what is Connecticut’s weighted average number of shares outstanding during 20X5?
A)210,000.
B)140,000.
C)150,000.
Connecticut’s January 1 balance of common shares outstanding is adjusted retroactively for the 1 for 3 reverse stock split, meaning there are (360,000 / 3) = 120,000 “new” shares treated as if they had been outstanding since January 1. The weighted average of the shares issued in July, (60,000 × 6 / 12) = 30,000 is added to that figure, for a total of 150,000.
The following data pertains to the McGuire Company:
Net income equals $15,000.
5,000 shares of common stock issued on January 1.
10% stock dividend issued on June 1.
1000 shares of common stock were repurchased on July 1.
1000 shares of 10%, par $100 preferred stock each convertible into 8 shares of common were outstanding the whole year.
What is the company’s basic earnings per share (EPS)?
A)$2.50.
B)$1.20.
C)$1.00.
Number of average shares:
1/1 5,500 shares issued (includes 10% stock dividend on 6/1) × 12 = 66,000
7/1 1,000 shares repurchased × 6 months = 6,000
66,000 − 6,000 = 60,000
60,000 shares / 12 months = 5,000 average shares
Preferred dividends = ($10)($1,000) = $10,000
Basic EPS = [$15,000(NI) – $10,000(preferred dividends)] / 5,000 shares = $5,000 / 5,000 shares = $1/share
For a firm with a simple capital structure, all of the following are necessary to measure basic earnings per share (EPS) EXCEPT:
A)dividends paid to common shareholders.
B)the timing and number of shares issued or repurchased during the year.
C)dividends paid to preferred shareholders.
Basic EPS = earnings available to common shareholders divided by the weighted average number of common shares outstanding. Earnings available to common shareholders equals net income minus preferred dividends.
As of the beginning of the year HalfPass Productions, Inc., had the following complex capital structure:
3,000,000 common shares outstanding.
175,000 options with an exercise price of $22.
250,000 warrants with an exercise price of $18.
During the year:
On March 1, the company issued 100,000 new shares of common stock.
On July 1, the board of directors declared a 15% stock dividend.
On September 1, the company repurchased 125,000 shares.
Net income (after-tax) for the year was $7,500,000.
The company paid common dividends of $2,750,000 and preferred dividends of $1,300,000.
The average market price for the common stock was $25 per share.
Assume the fiscal year is January 1 through December 31. At year end, HalfPass’s basic EPS is closest to:
A)$1.77.
B)$1.66.
C)$1.94.
3,000,000X1.15 X 1 common shares outstanding.=3450000
On March 1, the company issued 100,000 new shares of common stock.=100000X0.75X1.15 = 86250
On September 1, the company repurchased 125,000 shares.= Substract 125000X1/3 = 41666
Total Shares = 3450000+86250-41666= 3494584
7,500,000.-1,300,000.=6200000
EPS =6200000/3494584= 1.77
Washington, Inc.’s stock transactions during the year 20X4 were as follows:
January 1 - 720,000 shares issued and outstanding
May 1 2 for 1 stock split occurred
What was Washington’s weighted average number of shares outstanding during 20X4, for earnings per share (EPS) computation purposes?
A) 1,500,000.
B)1,666,667.
C)1,440,000.
The January 1 balance is adjusted retroactively for the stock split and (720,000 × 2 =) 1,440,000 shares are treated as outstanding from January.
A firm has a weighted average number of 20,000 common shares selling at an average of $10 throughout the year and 11,000, 10%, $100 par value preferred shares. If the firm earns $210,000 after taxes, what is its Basic EPS?
A)$5.00 / share.
B)$7.50 / share.
C)$10.50 / share.
The January 1 balance is adjusted retroactively for the stock split and (720,000 × 2 =) 1,440,000 shares are treated as outstanding from January.
(210,000 − 110,000) / 20,000 = $5 share
Zichron, Inc., had the following equity accounts on December 31:
Common stock: 20,000 shares.
Preferred stock A: 10,000 shares convertible into common on a 2 for 1 basis, dividend of $40,000 was declared during the year.
Preferred stock B: 10,000 shares, convertible to common on a 4 for 1 basis, dividend of $5,000 was declared during the year.
The company reported net income of $120,000 and paid a $20,000 dividend to its common shareholders.
What are the basic earnings per share reported for the year?
A)$2.75.
B)$2.00.
C)$3.75.
$120,000 − 40,000 − 5,000) / 20,000 shares = $3.75
What are the diluted earnings per share reported for the year?
A)$3.00.
B)$1.50.
C)$1.33.
($120,000) / (20,000 + 20,000 + 40,000) = $1.50.
The weighted average number of common shares outstanding is the number of shares outstanding during the year weighted by the portion of the year they were outstanding. Dividends and splits are applied to all shares issued or repurchased and all original or adjusted shares outstanding prior to the split or dividend.
An analyst gathered the following information about a company:
01/01/04 - 50,000 shares issued and outstanding at the beginning of the year
04/01/04 - 5% stock dividend
10/01/04 - 10% stock dividend
What is the company’s weighted average number of shares outstanding at the end of 2004?
A)57,500.
B)55,000.
C)57,750.
Step 1) Apply the 04/01/04 dividend to the beginning-of-year shares: Adjusted shares = 1.05 × 50,000 = 52,500
Step 2) Apply the 10/01/04 dividend the adjusted beginning-of-year shares. Adjusted beginning of year shares = 57,750 (= 1.1 × 52,500).
Step 3) Compute the weighted average number of shares. 57,750 × (12/12) = 57,750 shares
Last year, the AKB Company had net income equal to $5 million. Combined state and local taxes were 45%. The firm paid $1 million to holders of its 1 million common shares and $250,000 to 100,000 preferred shareholders. What was AKB’s earnings per share (EPS) last year?
A)$4.75.
B)$2.25.
C)$2.50.
EPS = earnings available to common shareholders divided by the weighted average number of common shares outstanding. Earnings available to common shareholders is net income minus preferred dividends, or $4,750,000 (= $5 million – 250,000) for AKB.
At the beginning of 2004, the Alaska Corporation had 2 million shares of common stock outstanding and no preferred stock. At the end of August, 2004, Alaska issued 600,000 new shares of common stock. If Alaska reported net income equal to $8.8 million, what was the firm’s earnings per share for 2004?
A)$3.38.
B)$4.00.
C)$3.67.
EPS = earnings available to common shareholders divided by the weighted average number of common shares outstanding. With no preferred shareholders, all of net income is available to the common shareholders. The weighted average number of shares outstanding equals the original 2 million shares plus 4/12 of the additional 600,000 shares. The 4/12 weight is used because the new shares were only outstanding 4 months of the year. Thus, EPS = $8.8 million / [2 million + (4/12)(600,000)] = 8.8/2.2 = $4.00.
An analyst gathered the following information about a company:
01/01/06 - 20,000 shares issued and outstanding
04/01/06 - 5.0% stock dividend
07/01/06 - 5,000 shares repurchased
10/01/06 - 2:1 stock split
What is the company’s weighted average number of shares outstanding at the end of 2006?
A)47,000.
B)37,000.
C)39,500.
The end-of-period weighted average number of common shares outstanding is the number of shares outstanding during the year weighted by the portion of the year they were outstanding. Dividends and splits are applied to all shares issued or repurchased and all original or adjusted shares outstanding prior to the split or dividend.
Step 1) Apply the 04/01/06 dividend to the beginning of year shares:
Adjusted shares = 1.05 × 20,000 = 21,000
Step 2) Apply the 10/01/06 split to the adjusted beginning-of-year shares and the repurchase.
Adjusted beginning-of-year shares = 42,000 (= 2 × 21,000)
Adjusted repurchase = 10,000 (= 2 × 5,000)
Step 3) Compute the weighted average number of shares.
42,000(12/12) - 10,000(6/12) = 37,000 shares
Maine Company’s stock transactions during the year are described below:
January 1 100,000 common shares outstanding
March 1 2 for 1 stock split
August 1 10% stock dividend
The weighted average number of shares outstanding used to calculate earnings per share is:
A)211,111.
B)201,666.
C)220,000.
The January 1 balance of common shares outstanding is adjusted retroactively for both stock dividends and stock splits. The weighted average shares outstanding for the year = 100,000 × 2 × 1.1 = 220,000.
A firm’s financial statements reflect the following:
Net income-$1,700,000
EBIT-$2,900,000
Effective tax rate-35%
Interest payments-$285,000
Common equity-$3,100,000
Total assets-$6,600,000
Preferred dividends paid-$1,100,000
Weighted avg. shares outstanding-523,000
Based on this information, what is the firm’s basic EPS?
A)$2.75.
B)$1.15.
C)$3.25.
The firm’s basic EPS = ($1,700,000 – $1,100,000) / (523,000) = $1.147.
Suppose that JPK, Inc., paid dividends of $80,000 to its preferred shareholders and $40,000 to its common shareholders during 2004. The company had 20,000 shares of common stock issued and outstanding on January 1, 2004, issued 7,000 more shares on June 1, 2004, and paid a 10% stock dividend on August 1, 2004. Assuming that JPK had $150,000 in net income, what is the firm’s basic earnings per share (EPS) for 2004?
A)$2.71.
B)$2.64.
C)$2.91.
1/1/00 22,000 shares (adjusted for 10% stock dividend) × 12 months = 264,000
6/1/00 7,700 shares (adjusted for 10% stock dividend) × 7 months = 53,900
Total share month = 317,900
Average shares = 317,900 / 12 = 26,492
Basic EPS = ($150,000 − $80,000) / 26,492 = 2.64
The following data pertains to the Megatron company:
Net income equals $15,000.
5,000 shares of common stock issued on January 1.
10% stock dividend issued on June 1.
1000 shares of common stock were repurchased on July 1.
1000 shares of 10%, par $100 preferred stock each convertible into 8 shares of common were outstanding the whole year.
How many common shares should be used in computing the company’s basic earnings per share (EPS)?
A)4,500.
B)5,000.
C)5,500.
1/1 5,500 shares issued (includes 10% stock dividend on 6/1) × 12 = 66,000
7/1 1,000 shares repurchased × 6 months = 6,000
66,000 − 6,000 = 60,000 shares
60,000 shares / 12 months = 5,000 average shares
:- A company has the following sequence of events regarding their stock:
One million shares outstanding at the beginning of the year.
On June 30th, they declared and issued a 10% stock dividend.
On September 30th, they sold 400,000 shares of common stock at par.
Basic earnings per share at year-end will be computed on how many shares?
A)1,000,000.
B)1,200,000.
C)1,100,000.
= 1 million stays for the entire year
=0.1 million (10% Stock Dividended) stays for the entire year
= 400000 is equal to 400000x3/12 = 0.1 million additional shares issued in sep
Total Shares outstanding will be = 1+0.1+0.1 =1.2 Million
Moulding Company’s net income was $13,820,000 with 2,600,000 shares outstanding. The average share price for the year was $58.00. Moulding had 10,000 options to purchase 10 shares each at $40 per share outstanding the entire year. Moulding Company’s diluted earnings per share are closest to:
A)$5.25.
B)$3.71.
C)$5.32.
Moulding’s basic EPS (net income / weighted average common shares outstanding) was $13,820,000 / 2,600,000 = $5.32.
Using the treasury stock method to compute diluted EPS, if the options were exercised, cash inflow would be 10,000 × 10 × $40 = $4,000,000. Based on the average share price of $58.00, the number of Moulding shares that can be purchased with the cash flow is $4,000,000 / $58 = 68,966. The number of shares that would have been created is 100,000 – 68,966 = 31,034. Diluted EPS was $13,820,000 / (2,600,000 + 31,034) = $5.25.
What is the treatement of preference shares when calculating the diluted EPS ?
In calculating both Basic and Diluted the prefrence share dividened is deducted from the NI .
Though it does not have any effect on the no of shares .
An analyst compiled the following information from Hampshire, Inc.’s financial activities in the most recent year:
§ Net income was $2,800,000.
§ 100,000 shares of common stock were outstanding on January 1.
§ The average market price per share for the year was $250.
§ 10,000 shares of 6%, $1,000 par value preferred shares were outstanding the entire year.
§ 10,000 warrants, which allow the holder to purchase 10 shares of common stock for each warrant held at a price of $150 per common share, were outstanding the entire year.
§ 30,000 shares of common stock were issued on September 1.
Hampshire, Inc.’s diluted earnings per share are closest to:
A)$18.38.
B)$20.00.
C)$14.67.
To compute Hampshire’s basic EPS ((net income – preferred dividends) / weighted average common shares outstanding), the weighted average common shares must be computed. 100,000 shares were outstanding from January 1, and 30,000 shares were issued on September 1, so the weighted average is 100,000 + (30,000 × 4 / 12) = 110,000. Basic EPS is ($2,800,000 – (10,000 × $1,000 × 0.06)) / 110,000 = $20.00.
If the warrants were exercised, cash inflow would be 10,000 × $150 × 10 = $15,000,000 for 10 × 10,000 = 100,000 shares. Using the treasury stock method, the number of Hampshire shares that can be purchased with the cash inflow (cash inflow / average share price) is $15,000,000 / $250 = 60,000. The number of shares that would be created is 100,000 – 60,000 = 40,000. Diluted EPS is $2,200,000 / (110,000 + 40,000) = $14.67
If the convertible preferred stock was converted to common stock then additional common shares would have been issued, dividends on the preferred stock would not have been paid . True or False
True
Selected information from Feder Corp.’s financial activities for the year is as follows:
Net income was $7,650,000.
1,100,000 shares of common stock were outstanding on January 1.
The average market price per share was $62.
Dividends were paid during the year.
The tax rate was 40%.
10,000 shares of 6% $1,000 par value preferred shares convertible into common shares at a rate of 20 common shares for each preferred share were outstanding for the entire year.
70,000 options, which allow the holder to purchase 10 shares of common stock at an exercise price of $50 per common share, were outstanding the entire year.
Feder Corp.’s diluted earnings per share (EPS) was closest to:
A)
$5.87.
B)
$4.91.
C)
$5.32.
Feder’s basic earnings per share ((net income – preferred dividends) / weighted average shares outstanding) was (($7,650,000 – ($1,000 × 10,000 × 0.06)) / 1,100,000 =) $6.41.
If the convertible preferred stock was converted to common stock at January 1, (10,000 × 20 =) 200,000 additional common shares would have been issued, dividends on the preferred stock would not have been paid, and Diluted EPS would have been ($7,650,000 / (1,100,000 + 200,000) = $5.88. Because $5.88 is less than basic EPS of $6.41, the preferred shares are dilutive.
Using the treasury stock method, if the options were exercised cash inflow would be (70,000 × 10 × $50 =) $35,000,000. The number of Feder shares that can be purchased with the inflow (cash inflow divided by the average share price) is ($35,000,000 / $62 =) 564,516.
The number of shares that would have been created is (700,000 – 564,516 =) 135,484. Diluted EPS was ($7,650,000 / (1,100,000 + 135,484) =) $6.19. Because this is less than the EPS of $6.41, the options are dilutive.
Combining the calculations, Diluted EPS was (($7,650,000) / (1,100,000 + 200,000 + 135,484) = $5.32.
In applying the treasury stock method, if warrants allow the purchase of 1 million shares at $42 per share when the average price is $56 per share, how many shares will be added to the firm’s weighted average number of shares outstanding?
A)1,000,000.
B)250,000.
C)420,000.
The treasury stock method would allow the 1 million additional shares to be partially offset by the number of shares that could be repurchased with the amount of money received for those shares. In this case, the 1 million shares issued would be offset by (1,000,000 × $42 / $56) or 750,000 shares. B
Cassie Hamilton is an analyst with Pacers Worldwide, an investment banking firm. She just received the following information (as of year-end) for Trotters Diversified:
Average common shares outstanding of 5.0 million.
Average market price for common stock of $35.00 per share.
Net income of $9.0 million.
Common stock dividends paid of $1.2 million.
Preferred dividends paid (on convertible preferred stock noted below) of $1.5 million.
Tax rate of 40%.
500,000 shares of cumulative convertible preferred stock with $30 par value and 10% dividend. Each preferred share is convertible into 5 common shares.
10,000 convertible $1,000 par bonds with a 6.0% coupon, each convertible into 8 shares of common stock.
400,000 stock options recently issued with an exercise price of $32.00 per share.
In the denominator of the basic EPS calculation, Hamilton should include how many shares related to the convertible bonds?
A)0.
B)80,000.
C)10,000.
The calculation for basic EPS excludes the impact of complex capital elements. A
Cassie Hamilton is an analyst with Pacers Worldwide, an investment banking firm. She just received the following information (as of year-end) for Trotters Diversified:
Average common shares outstanding of 5.0 million.
Average market price for common stock of $35.00 per share.
Net income of $9.0 million.
Common stock dividends paid of $1.2 million.
Preferred dividends paid (on convertible preferred stock noted below) of $1.5 million.
Tax rate of 40%.
500,000 shares of cumulative convertible preferred stock with $30 par value and 10% dividend. Each preferred share is convertible into 5 common shares.
10,000 convertible $1,000 par bonds with a 6.0% coupon, each convertible into 8 shares of common stock.
400,000 stock options recently issued with an exercise price of $32.00 per share.
What is the diluted EPS ?
A)1.19
B)1.23
C)1.50
101 b:- As we will show below, only the options and convertible preferred stock are dilutive.
First, calculate basic EPS to use as a benchmark to determine dilutive capital components.
Basic EPS = (net income – preferred dividends) / weighted average common shares outstanding
Here, preferred dividends = (0.5 shares × $30 par × 0.10 dividend) = $1.5 million = (9.0 – 1.5) / 5.0 = $1.50. Now, check for dilutive elements.
options are dilutive because the exercise price is less than the stock price. There is no numerator impact from the options. The denominator impact = # options – [(# options × exercise price) / average stock price)] = 400,000 – [(400,000 × 32) / 35] = 34,286 or 0.034 million.
To check whether the convertible preferred stock is dilutive we need to determine whether it decreases EPS. To the numerator, we add back the preferred dividend. The denominator impact = (# preferred shares × conversion rate) = 500,000 × 5 = 2,500,000, or 2.5 million. Then, EPS = (9.0 – 1.5 + 1.5) / (5.0 + 2.5) = $1.20. Thus the convertible preferred stock is dilutive.
To check whether the convertible bonds are dilutive we need to determine whether they decrease EPS. To the numerator, we add back the after-tax impact of the coupon, or (face value × coupon × (1 − t)), or (10,000 bonds × 1,000 par × 0.06 coupon × 0.6 ) = 360,000, or $0.360 million. The denominator impact = (# convertible bonds × conversion rate) = 10,000 × 8 = 80,000, or 0.080 million. Then, EPS = (9.0 – 1.5 + 0.360) / (5.0 + 0.080) = $1.55. Thus the bonds are antidilutive.
Finally, calculate dilutive EPS:
Diluted EPS = (9.0 – 1.5 + 1.5) / (5.0 + 2.5 + 0.034) = approximately $1.19
All of the following are considered a potentially dilutive securities EXCEPT:
A)preferred stock.
B)stock options.
C)warrants
Not all preferred stock dilutive . Only convertible preferred stock is potentially dilutive. A
103:- Examples of potentially dilutive securities include all of the following EXCEPT:
A)non-convertible bonds.
B)convertible preferred stock.
C)options.
Preferred stock and bonds are only considered to be potentially dilutive if they are convertible. Options are always considered to be potentially dilutive. A
104:- When calculating earnings per share (EPS) for firms with complex capital structures, stock options are ordinarily considered to be:
A)potentially dilutive securities.
B)antidilutive securities.
C)derivative securities.
Dilutive securities are securities that decrease EPS if they are exercised or converted to common stock. When the exercise price is less than the average market price, stock options are considered to be dilutive, Stock options, warrants, convertible debt, and convertible preferred stock are examples of potentially dilutive securities.A
When calculating earnings per share (EPS) for firms with complex capital structures, convertible bonds are ordinarily considered to be:
A)embedded debt securities.
B)potentially dilutive securities.
C)antidilutive securities.
Dilutive securities are securities that decrease EPS if they are exercised or converted to common stock. Stock options, warrants, convertible debt, and convertible preferred stock are examples of potentially dilutive securities. Note that if diluted EPS when considering the convertible bonds is greater than basic EPS, the convertible bonds would be antidilutive and should not be treated as common stock in computing diluted EPS B
When calculating earnings per share (EPS) for firms with complex capital structures, convertible preferred stock is ordinarily considered to be a:
A)non-equity security.
B)potentially dilutive security.
C)antidilutive security.
106 :-Dilutive securities are securities that decrease EPS if they are exercised or converted to common stock. Stock options, warrants, convertible debt, and convertible preferred stock are examples of potentially dilutive securities. Note that if diluted EPS when considering the convertible preferred stock is greater than basic EPS, the convertible preferred stock would be antidilutive and should not be treated as common stock in computing diluted EPS. B
107:- Which of the following statements regarding the treasury stock method of computing diluted shares is least accurate? The treasury stock method:
A)assumes that the hypothetical funds received by the company from the exercise of the options are used to sell shares of the company’s common stock in the market at the average market price.
B)is used when the exercise price of the option is less than the average market price.
C)increases the total number of shares by less than the number that the exercise of the options would create.
The treasury stock method assumes any funds received by the company from the exercise of the options are used to purchase shares (not sell shares) of the company’s common stock in the market at the average market price. A
Which of the following statements is CORRECT regarding the reporting of earnings per share (EPS)?
A)Diluted EPS must be less than or equal to basic EPS.
B)The EPS when antidilutive securities are converted into shares of common stock is less than basic EPS.
C)Basic EPS can be less than diluted EPS.
Antidilutive securities are securities that would increase EPS if exercised or converted to common stock.A
Based on the following data, how many shares of common stock should be used to calculate diluted earnings per share?
Net income of $1,500,000, tax retention rate of 60%
1,000,000 shares of common are outstanding at the beginning of the year.
10,000, 6% convertible bonds with each bond convertible into 20 shares of common stock were issued at par ($100) on June 30th of this year.
The firm has 100,000 warrants outstanding all year with an exercise price of $25 per share.
The average stock price for the period is $20, and the ending stock price is $30.
A)
1,266,667.
B)
1,000,000.
C)
1,100,000.
First, Check for dilution: Basic EPS = 1,500,000 / 1,000,000 = 1.50
Warrants: anti-dilutive since the average stock price is less than the exercise price
Convertible bonds: numerator impact = (# bonds) × (par value) × (interest rate) × (tax retention rate) × (0.5 for 1/2 year outstanding) = (10,000) × (100) × (0.06) × (0.6) × (0.5) = 18,000, so the numerator = 1,518,000 Denominator impact: increase in average shares = [(# bonds) × (conversion factor) × (# months outstanding)] / 12 = (1,200,000 / 12 = 100,000) so, the denominator = 1,100,000 and EPS with conversion = 1,518,000 / 1,100,000 = 1.38, which is less than 1.50. The bonds are dilutive and the diluted EPS calculation should use 1,100,000 shares of common stock in the denominator. The warrants are out of the money based on the average price of $20.
110:- Selected information from Doors, Inc.’s financial activities in the year 2005 included the following:
§ Net income was $372,000.
§ 100,000 shares of common stock were outstanding on January 1.
§ The average market price per share was $18 in 2005.
§ Dividends were paid in 2005.
§ 2,000, 6 percent $1,000 par value convertible bonds, which are convertible at a ratio of 25 shares for each bond, were outstanding the entire year.
§ Doors, Inc.’s tax rate is 40%.
Doors, Inc.’s diluted earnings per share (Diluted EPS) for 2005 was closest to:
A)$2.96.
B)$3.72.
C)$3.28.
Doors basic earnings per share (EPS) was ($372,000 / 100,000 =) $3.72. If the bonds were converted, interest payments would not have been made. Net income is increased by the interest paid on the bonds net of taxes: $372,000 + (($1000 × 2,000 × 0.06) × (1 − 0.40)) = $444,000.
Diluted EPS was $444,000 / (100,000 + (2,000 × 25)) = $2.96.
Selected information from Gerrard, Inc.’s financial activities in the most recent year was as follows:
§ Net income was $330,000.
§ The tax rate was 40%.
§ 700,000 shares of common stock were outstanding on January 1.
§ The average market price per share for the year was $6.
§ Dividends were paid during the year.
§ 2,000 shares of 8% $500 par value preferred shares, convertible into common shares at a rate of 200 common shares for each preferred share, were outstanding for the entire year.
§ 200,000 shares of common stock were issued on March 1.
Gerrard, Inc.’s diluted earnings per share (diluted EPS) was closest to:
A)$0.289.
B)$0.197.
C)$0.261.
To compute Gerrard’s basic earnings per share (EPS) ((net income – preferred dividends) / weighted average common shares outstanding), the weighted average common shares outstanding must be computed. 700,000 shares were outstanding from January 1, and 200,000 shares were issued on March 1, so the weighted average is 700,000 + (200,000 × 10 / 12) = 866,667. Basic EPS was $330,000 − (2,000 × $500 × 0.08)) / 866,667 = $0.289.
If the convertible preferred shares were converted to common stock, 2,000 × 200 = 400,000 additional common shares would have been issued and dividends on the preferred stock would not have been paid. Diluted EPS was $330,000 / (866,667 + 400,000) = $0.261.
112:- Protocol, Inc.’s net income for 2005 was $4,800,000. Protocol had 800,000 shares of common stock outstanding for the entire year. The tax rate was 40 percent. The average share price in 2005 was $37.00. Protocol had 5,000 8 percent $1,000 par value convertible bonds that were issued in 2004. Each bond is convertible into 25 shares of common stock. Protocol, Inc.’s basic and diluted earnings per share for 2005 were closest to:
Basic EPS Diluted EPS
A) $6.00 $4.92
B) $5.19 $4.92
C)$6.00 $5.45
Protocol’s basic EPS (net income / weighted average common shares outstanding) was $4,800,000 / 800,000 = $6.00. Diluted EPS is calculated under the assumption that the convertible bonds were converted into common stock, and the bond interest net of tax was restored to net income. The common shares from the conversion of the bonds are added to the denominator of the equation. Protocol’s Diluted EPS was [$4,800,000 + (5,000 × $1,000 × 0.08)(1 − 0.40)] / [800,000 + (5,000 × 25)] = $5.45.
To calculate diluted EPS, dividends on convertible preferred stock and the after tax interest on convertible debt need to be added to net income in the numerator. If diluted EPS are more than basic EPS, the convertible securities are antidilutive and should not be used in computing diluted EPS.
Orange Company’s net income for 2004 was $7,600,000 with 2,000,000 shares outstanding. The average share price in 2004 was $55. Orange had 10,000 shares of eight percent $1,000 par value convertible preferred stock outstanding since 2003. Each preferred share was convertible into 20 shares of common stock. Orange Company’s diluted earnings per share (Diluted EPS) for 2004 is closest to:
A)$3.45.
B)$3.80.
C)$3.40.
Orange’s basic EPS ((net income – preferred dividends) / weighted average common shares outstanding) is [($7,600,000 − (10,000 × $1,000 × 0.08)] / 2,000,000 = $3.40. To check for dilution, EPS is calculated under the assumption that the convertible preferred shares are converted into common shares at the beginning of the year. The preferred dividends paid are added back to the numerator of the Diluted EPS equation, and the additional common shares are added to the denominator of the equation. Orange’s if-converted EPS is $7,600,000 / (2,000,000 + 200,000) = $3.45. Because if-converted EPS is higher than basic EPS, the preferred stock is antidilutive and no adjustment is made to basic EPS.
115:-The primary difference between basic EPS and diluted EPS is that:
A)diluted EPS includes the potential effects of convertible securities while basic EPS does not.
B)proprietors and partners report basic EPS but corporations report diluted EPS.
C)extraordinary items and discontinued operations are omitted from basic EPS but included in diluted EPS.
The primary difference between basic EPS and diluted EPS is that diluted EPS includes the potential effects of convertible securities while basic EPS does not.A
116:- Advantage Corp.’s capital structure was as follows:
December 31, 2005
December 31, 2004
Outstanding shares of stock:
Common
110,000
110,000
Convertible Preferred
10,000
10,000
8% Convertible Bonds
$1,000,000
$1,000,000
During 2005, Advantage paid dividends of $3 per share on its preferred stock. The preferred shares are convertible into 20,000 shares of common stock. The 8% bonds are convertible into 30,000 shares of common stock. Net income for 2005 was $850,000. Assume the income tax rate is 30%.
Calculate Advantage’s basic and diluted earnings per share (EPS) for 2005.
Basic EPS Diluted EPS
A)$7.45 $5.66
B)$6.31 $5.66
C)$7.45 $6.26
:-Basic EPS = net income − pref div / wt. ave. shares of common
[850,00 − (3 × 10,000)] / 110,000 = $7.45
Diluted EPS = [(net income − preferred dividends) + convertible preferred dividends + (convertible debt interest)(1 − t)] / [(weighted average shares) + (shares from conversion of conv. pfd shares) + (shares from conversion of conv. debt) + (shares issuable from stock options)]
[(850,000 − (3 × 10,000)) + 30,000 + (80,000)(1 − 0.3)] / [(110,000) + (20,000) + (30,000)] = $5.66.
Securities that would decrease earnings per share (EPS) if they were exercised and converted to common stock are called:
A)synthetic securities.
B)dilutive securities.
C)antidilutive securities.
117-Dilutive securities are securities that decrease EPS if they are exercised or converted to common stock. Stock options, warrants, convertible debt, and convertible preferred stock are examples of dilutive securities.B
118:-Securities that improve basic per share earnings, or reduce per share losses, if they are exercised or converted to common stock are called:
A)antidilutive securities.
B)dilutive securities.
C)embedded securities.
118:-Antidilutive securities, upon exercise, increase basic EPS or decrease per share losses. Shares from conversion are not included in the calculation of basic or diluted EPS.A
Which of the following statements about the earnings per share calculation are most accurate?
A)None of these choices are correct.
B)When calculating diluted EPS you must add the shares created from the conversion of the bonds to the denominator and the interest expense times the tax rate to the numerator.
C)If the diluted EPS is less than the basic EPS, then the diluted EPS is said to be anti-dilutive.
Anti-dilutive is when dilutive EPS > basic EPS. When calculating diluted EPS, you must add the shares created from the conversion of the bonds to the denominator and the interest (1 – tax rate) to the numeratorA
120:-Anti-dilutive securities should:
A)be used in calculating basic EPS but not diluted EPS.
B)be used in calculating diluted EPS but not basic EPS.
C)not be used in calculating basic or diluted EPS.
120:-Antidilutive securities would increase EPS if exercised or converted to common stock.C
121:-How will dilutive securities affect earnings per share (EPS) when determining diluted earnings per share?
A)Increase EPS.
B)Either decrease or increase EPS depending upon if the security is dilutive or antidilutive.
C)Decrease EPS.
121:-Dilutive securities such as convertibles and options are found in a complex capital structure and always decrease EPS. Convertibles and options may also be antidilutive, which will increase EPS hence the name antidilutive. The only way to know if a security is dilutive or antidilutive is to compare the basic EPS to diluted EPS. If the diluted EPS is higher than the basic EPS then the security is antidilutive and should not be included when determining diluted EPS. C
122:- In calculating the numerator for diluted Earnings Per Share, the interest on convertible debt is:
A)added to earnings available to common shareholders after an adjustment for taxes.
B)subtracted from earnings available to common shareholders after an adjustment for taxes.
C)added to earnings available to common shareholders
:-Formula = Diluted EPS = [(Net income − Preferred dividends) + Convertible preferred dividends + (Convertible debt interest)(1 − t)] / [(Weighted average shares) + (Shares from conversion of conv. pfd shares) + (Shares from conversion of conv. debt) + (Shares issuable from stock options)]A
An analyst has gathered the following information about Artcraft, Inc. for the year:
Net income of $30,000.
5,000 shares of common stock and 500 shares of 8%, $90 par convertible preferred stock outstanding during the whole year.
Each share of convertible preferred can be converted into 4 shares of common stock.
Last year, Artcraft issued at par, $60,000 total face value of 6.0% convertible bonds, with each of the 60 bonds convertible into 110 shares of the Artcraft common stock.
If Artcraft’s effective tax rate is 40%, what will Artcraft report as diluted earnings per share (EPS)?
A)$3.12.
B)$3.37.
C)$2.36.
123:- Diluted EPS = adjusted earnings after conversion (EAC) / weighted average plus potential common shares outstanding.
Step 1: Calculate Adjusted EAC
adjusted EAC: net income - preferred dividends
+
dividends on convertible preferred stock
+
after-tax interest on convertible debt
=adjusted earnings available for common shares
preferred dividends = convertible preferred dividends = (0.08)(90)(500) = 3,600
convertible debt interest = (60,000)(0.06)(1 – 0.40) = 2,160
adjusted EAC = (30,000 – 3,600 + 3,600 + 2,160) = $32,160
Step 2: Calculate Weighted average plus potential common shares outstanding.
weighted average common shares=5,000
shares from conversion of convertible preferred stock
=(500 × 4)=2,000
shares from conversion of convertible bonds =(60 × 110)
=6,600
weighted ave. plus potential common shares outst.=13,600
Step 3: Calculate Diluted EPS
Diluted EPS = 32,160 / 13,600 = $2.36.
In calculating the numerator for diluted earnings per share, the dividends on convertible preferred stock are:
A)added to earnings available to common shareholders with an adjustment for taxes.
B)subtracted from earnings available to common shareholders without an adjustment for taxes.
C)added to earnings available to common shareholders without an adjustment for taxes
Diluted EPS = [(Net income − Preferred dividends) + Convertible preferred dividends + (Convertible debt interest)(1 − t)] / [(Weighted average shares) + (Shares from conversion of conv. pfd shares) + (Shares from conversion of conv. debt) + (Shares issuable from stock options)]C
An analyst has gathered the following information about Barnstabur, Inc., for the year:
Reported net income of $30,000.
5,000 shares of common stock and 2,000 shares of 8%, $90 par preferred stock outstanding during the whole year.
During the year, Barnstabur issued at par, $60,000 of 6.0% convertible bonds, with each of the 60 bonds convertible into 110 shares of the Barnstabur common stock.
If Barnstabur’s effective tax rate is 40%, what will Barnstabur report for diluted earnings per share (EPS)?
A)$2.36.
B)$1.66.
C)$1.53.
Diluted EPS = adjusted earnings after conversion (EAC) / weighted average plus potential common shares outstanding.
Step 1: Calculate Adjusted EAC
adjusted EAC: net income - preferred dividends+after-tax interest on convertible debt=adjusted earnings available for common shares
preferred dividends = (0.08)(90)(2,000) = 14,400
convertible debt interest = (60,000)(0.06)(1 – 0.40) = 2,160
adjusted EAC = (30,000 – 14,400 + 2,160) = $17,760
Step 2: Calculate Weighted average plus potential common shares outstanding.
weighted average common shares
=5,000
shares from conversion of convertible bonds
=(60 × 110)=6,600
weighted ave. plus potential common shares outst.
=11,600
Step 3: Calculate Diluted EPS
Diluted EPS = 17,760 / 11,600 = $1.53
Selected information from Baltimore Corp’s financial activities in the year 2004 is as follows:
Net income was $4,200,000 .
750,000 shares of common stock were outstanding on January 1.
The average market price per share was $50 in 2004.
Dividends were paid in 2004.
10,000 warrants, which allowed the holder to purchase 10 shares of common stock for each warrant held at a price of $40 per common share, were outstanding the entire year.
Baltimore’s diluted earnings per share (Diluted EPS) for 2004 is closest to:
A)$5.45.
B)$5.60.
C)$4.94.
Baltimore’s basic earnings per share (EPS) (net income / weighted average shares outstanding) for 2004 was $4,200,000 / 750,000 = $5.60.
To calculate diluted EPS, we use the treasury stock method to account for the warrants:
Number of common shares created if options are exercised = 10,000 × 10 = 100,000
Cash inflow if warrants are exercised = $40 × 100,000 = $4,000,000
Shares purchased with these funds = $4,000,000 / 50 = 80,000
Net increase in shares outstanding = 100,000 – 80,000 = 20,000
Diluted EPS = $4,200,000 / (750,000 + 20,000) = $5.45.
The Allen Corporation had 100,000 shares of common stock outstanding at the beginning of the year. Allen issued 30,000 shares of common May 1. On July 1, the company issued a 10% stock dividend. On September 1, Allen issued 1,000, 10% bonds convertible into 21 shares of stock each. What is the weighted average number of shares to be used in computing basic and diluted earnings per share (EPS), assuming the convertible bonds are dilutive?
Basic Shares Diluted Shares
A)130,000 132,000
B)132,000 139,000
C)132,000 146,000
128:- Calculating Basic Shares:
Jan 1 100,000 shares outstanding
May 1 30,000 shares issued
July 1 10% stock dividend issued
The 10% stock dividend is retroactive therefore:
110,000 shares × 12 months = 1,320,000
33,000 shares × 8 months = 264,000
Total share-month = 1,584,000
Average shares = (1,584,000 / 12) = 132,000
Calculating diluted shares:
(1,000 bonds) × (21 shares each) × (4 months) = 84,000 total share-month
84,000 / 12 = 7,000 Average shares
Total diluted shares = 7,000 (from convertible bonds) + 132,000 (from stock) = 139,000
Quad Associates, Inc.’s net income for 2005 was $892,000 with 400,000 shares outstanding. The tax rate was 40 percent. Quad had 2,000 six percent $1,000 par value convertible bonds that were issued in 2004. Each bond was convertible into 40 shares of common stock. Quad, Inc.’s diluted earnings per share (Diluted EPS) for 2005 was closest to:
A)$2.23.
B)$2.41.
C)$2.01.
Quad’s basic EPS (net income / weighted average common shares outstanding) was $892,000 / 400,000 = $2.23.
Diluted EPS is calculated under the assumption that the convertible bonds are converted into common stock, the bond interest net of tax is restored to net income, and the additional common shares are added to the denominator of the equation. Quad’s diluted EPS was [$892,000 + (2,000 × $1,000 × 0.06)(1 − 0.40)] / [400,000 + (2,000 × 40)] = $2.01. Since diluted EPS is less than basic EPS, we know that the bonds are dilutive and should be considered in calculating diluted EPS.
130:- Kendall Company’s net income for 20X4 is $830,000 with 200,000 shares outstanding. Kendall has 1,000 6% convertible bonds (each bond $1,000 face value and convertible into 20 common shares) outstanding for the entire year. Kendall’s tax rate is 40%. What is Kendall Company’s diluted earnings per share for 20X4?
A)$3.94.
B)$4.15.
C)$3.77.
Kendall’s basic EPS is $830,000 / 200,000 = $4.15. To compute diluted EPS, bond interest paid net of taxes is added to net income, and the number of shares that would be issued in the conversion is added to the denominator. Kendall’s diluted EPS = [$830,000 + (1,000 × $1,000 × 0.06) × (1 – 0.4)] / (200,000 + 20,000) = $3.94. Since diluted EPS is less than basic EPS, we know that the bonds are dilutive and should be considered in calculating diluted EPS.
131 :- Selected information from Caledonia, Inc.’s financial activities in the year 20X6 is as follows:
Net income = $460,000.
2,300,000 shares of common stock were outstanding on January 1.
The average market price per share was $2 and the year-end stock price was $1.50.
1,000 shares of 8%, $1,000 par value preferred shares were outstanding on January 1. Preferred dividends were paid in 20X6.
10,000 warrants, each of which allows the holder to purchase 100 shares of common stock at an exercise price of $1.50 per common share, were outstanding the entire year.
Caledonia’s diluted earnings per share for 20X6 are closest to:
A)$0.165.
B)$0.180.
C)$0.15.
Caledonia’s basic EPS = (net income − preferred stock dividends) / (weighted average common shares outstanding)
= [$460,000 − ($1,000 × 1,000 × 0.08)] / 2,300,000 = $0.17.
Using the treasury stock method, if the warrants were exercised, cash inflow would be 10,000 × 100 × $1.50 = $1,500,000. The number of Caledonia shares that could be purchased with the inflow, using the average share price, is $1,500,000 / $2 = 750,000. The net increase in common shares outstanding would have been 1,000,000 − 750,000 = 250,000.
Diluted EPS = $380,000 / (2,300,000 + 250,000) = $0.15.
133:- Nichols Company’s net income for 20X6 was $978,000 with 1,250,000 shares outstanding. The average share price in 20X6 was $8.50. Nichols issued 2,000 warrants to purchase 100 shares each for $10 per share in 20X5. Nichols Company’s diluted earnings per share (diluted EPS) for 20X6 is closest to:
A)
$0.782.
B)
$0.777.
C)
$0.793.
Nichols basic EPS (net income / weighted average common shares outstanding) was:
$978,000 / 1,250,000 = $0.782.
Because the exercise price of the warrants is higher than the average share price, the warrants are antidilutive and are excluded from diluted EPS. Because there were no other potentially dilutive securities, Nichols’ diluted EPS in 20X6 is the same as basic EPS.
132:- Young Distributors, Inc. issued convertible bonds two years ago, and those bonds are the only potentially dilutive security Young has issued. In 20X5, Young’s basic earnings per share (EPS) and diluted EPS were identical, but in 20X4 they were different. Which of the following factors is least likely to explain the difference between basic and diluted EPS? The:
A)average market price of Young common stock increased in 20X5.
B)bonds were redeemed by Young Distributors at the beginning of 2005.
C)bonds were antidilutive in 2005 but not in 2004.
Average stock price is not a factor in determining whether convertible bonds are dilutive or antidilutive.
If Young redeemed the bonds, they would have no potentially dilutive securities outstanding in 20X5 and diluted EPS, if the company reported it, would equal basic EPS. Basic and diluted EPS would also be equal in 20X5 if the bonds were antidilutive in that year.
