Class Notes Earnings Per Share Chapter 16, Section 2 pp.

921-933

1.

Simple Capital Structure: When there is only common stock or no securities that could dilute earnings per share (EPS) if converted or exercised EPS = (Net Income Available to Common) / Weighted average no. of shares outstanding Preferred Stock Dividends are the current years dividends only. -If none declared and the stock is cumulative, then calculate an amount equal to what the current dividend would have been -Do NOT include dividends in arrears -If a net loss occurs, increase the loss amount by the preferred dividend

a. b.

c.

Weighted Average No. of Shares Outstanding = # Shares outstanding * Fraction of the year outstanding -if a stock dividend or split occurs during the year, treat it as if it occurred at the beginning of the year

An Example: Kalin Corp. has 2012 net income of $1,000,000. During 2012 Kalin Corp. did not pay dividends however, they had 10% preferred stock with a total par value of 50,000. Determine Net Income Available to Common Assuming: 1. The preferred shares were cumulative

2.

The preferred shares were noncumulative

3.

There was a net loss of $1,000,000 and the preferred shares were cumulative

4.

Now assume that Kalin Corp.s preferred stock was cumulative and that dividends were not paid in 2011 (last year). Also assume that Kalin Corp. paid dividends in arrears (the 2011 dividend) plus the current years dividend to preferred shareholders in 2012.

2.

Complex Capital Structure: Occurs when a company has convertible securities, options, warrants, and other rights that upon conversion or exercise could dilute EPS Must report both Basic and Diluted EPS ( Note that Diluted EPS must always be Basic EPS)

a.

b. Diluted EPS includes the effects from dilutive potential common stock -Convertible Securities: use the if-converted method: (1) add the shares that would have been issued to the denominator and assume that the conversion occurred at the beginning of the year or at the issuance date if it occurred during the year (2) add back to the numerator the dividends on preferred or after-tax interest expense on bonds -Options and Warrants: use the treasury stock method: (1) assume that exercise occurs at the beginning of the year or issue date, if it occurs during the year. (2) assume that proceeds from options/warrants are used to purchase shares for the treasury; the incremental shares are added to the denominator.. incremental shares = potential shares issued for options/warrants less the number of shares that can be purchased with the proceeds from options/warrants. If market price is less than the option price no dilution occurs. -Contingent issuance agreements: shares issuable in the future for little or no cash consideration if a contingency is met. -Basic and Diluted EPS: include shares in denominator as soon as contingent event occurs -Diluted EPS: Compute number of shares to be issued if contingency were evaluated at year end. Add these shares to the denominator IF dilutive c. When is potential common stock dilutive? If it reduces diluted EPS - Use income from continuing operations as the control number for the dilution test - In cases where there is more than one potentially dilutive security - compute effect (change in numerator) / (change in denominator) and rank the effects from lowest to highest ignoring anti dilutive securities. Work down the list of dilutive securities recomputing diluted EPS after each one is incorporated. Stop when the list runs out or the next security becomes antidilutive .

EPS EXAMPLES
Problem #1: The following information was available for the Sutton Company at the beginning of 2008: The company is authorized to issue 8,000,000 shares of $10 par value common stock. As of December 31, 2007, 3,000,000 shares were outstanding 700,000 shares of convertible preferred stock had been issued on July 1, 2007. The stock was issued at its par value of $25, and it has a cumulative dividend of $3 per share. The stock is convertible into common stock at the rate of one share of convertible preferred for one share of common. The rate of conversion is automatically adjusted for stock splits and stock dividends. Dividends are paid quarterly on September 30, December 31, March 31 and June 30. Sutton is subject to a 40% income tax rate.

The following transactions occurred during 2008: - April 1 200,000 shares of preferred stock are converted into common shares. - July 1 a 2 for 1 split of the common stock became effective - August 1, A total of 300,000 shares of common stock were issued to acquire a factory building. - November 1, Sutton repurchased a total of 24,000 shares of common stock on the open market for $9 per share. - The after tax income for the year ended December 31, 2008 was $13,550,000 Required: a. Compute the weighted average number of shares to be used in computing basic EPS for 2008. b. Compute net income available to common to be used in computing basic EPS for 2008 c. Compute diluted EPS for 2008

Problem #2: The Lancaster Co. came into existence on June 1, 2003 with the issuance of 800,000 shares of common stock. Lancaster adopted a December 31 year-end. On April 1, 2008, the company issued an additional 400,000 shares of stock for cash. All 1,200,000 shares were outstanding on December 31, 2008. Lancaster also issued $600,000 of 20-year, 8% convertible bonds at par on July 1, 2008. Each $1,000 bond converts to 40 shares of common at any interest date. None of the bonds have been converted to date. Lancaster is preparing its annual report for 2008. The annual report will show earnings per share figures based upon a reported after-tax net income of $1,430,000 (the tax rate is 40%). a. Compute basic EPS for 2008

b.

Compute diluted EPS for 2008

c.

Assume the same facts except that the interest rate on the bonds equals 14% (the bonds were sold at par value). Compute diluted EPS for 2008. What numbers should appear in the 2008 Income Statement? K&W

Problem #3: The Coale Co. sold 12,000 options for its common stock in 2007; the holder can get one share of stock by turning in one option plus $10 of cash. The company also sold another 6,000 options on July 1, 2008, but these have exercise prices of $7.5 per share. As of the end of 2008, all of these options remain outstanding. The 2008 net income available to common is $86,800, and 20,000 common shares were outstanding during 2008. The average stock price for the year is $9.00. a. Compute basic EPS for Coale Co. for 2008

b.

Compute diluted EPS for Coale Co. for 2008

How would your answer change if net income available to common was a loss of $12,350?