Concept explainers
1.
Compute the basic earnings per share for Company M.
1.
Explanation of Solution
Earnings per share (EPS):
The amount of net income available to each shareholder per common share outstanding is referred to as earnings per share (EPS).
Compute the basic earnings per share for Company M.
Basic earnings per share =Net income−Preferred dividend(Weighted Average number of common shares outstanding(1))=$575,000−$60,000(5,000×$100×12%)$264,164=$515,000$264,164=$1.95
Working notes:
(1) Calculation of weighted average shares outstanding:
(Figure 1)
2.
Compute the tentative and incremental dilutive earnings per share for each dilutive security.
2.
Explanation of Solution
Compute tentative diluted EPS for stock options.
Tentative diluted EPS for stock options} = Net income –Preferred dividends(Weighted average number of common shares outstanding)= $575,000 – $60,000275,068 shares (3)= $1.87 per share
Compute the incremental diluted EPS for stock options.
Incremental diluted EPS} = Increase in EPS numeratorIncrease in EPS denominator=Increase in EPS numeratorIncrease in number of common shares=$0(275,068–264,167) common shares=$0
Compute the incremental diluted EPS for convertible bonds.
Incremental diluted EPS for convertible bonds} = Increase in EPS numerator(4)Increase in EPS denominator(5)=(Increase in EPS due to decrease in interest expense, net of taxes)Increase in number of common shares=$34,56019,200 common shares=$1.80
Compute the incremental diluted EPS of convertible preferred stock.
Incremental diluted EPS of convertible preferred stock} = Increase in EPS numeratorIncrease in EPS denominator(6) =(Increase in numerator due to decrease in preferred dividend)Increase in number of common shares=$60,00075,000 common shares=$0.08
Compute tentative diluted EPS assuming for 12% convertible preferred stock.
Tentative diluted EPS }= (Net income –Preferred dividends)+Preferred dividendsWeighted average number of common shares outstanding= $575,000 –$60,000+ $60,000275,068 shares+75,000 shares=$575,000350,068 shares= $1.64 per share
Compute tentative diluted EPS assuming, exercisable options, 9% convertible bonds, and 12% convertible preferred stock.
Diluted EPS = {(Net income –Preferred dividends)+Preferred dividends+After-tax interest savings}Weighted average number of common shares outstanding= $575,000 –$60,000+ $60,000+$34,560275,068 shares+75,000 shares+19,200 shares=$609,560369,268 shares= $1.65 per share
Working notes:
(1) Calculate the value of exercisable options:
Exercisable options value = Number of shares × Exercise price= 22,000 shares × $15= $330,000
(2) Compute the number of shares required:
Number of shares assumed reacquired} = Exercisable optionsAverage market price per share= $330,000 (1)$37= 8,919 shares
(3) Compute the total weighted average number of common shares.
(Figure 2)
(4) Compute the amount of interest expense, net of income tax on 9% bonds.
Interest expense, net of taxes}=(Face value of bonds ×Stated interest rate)×(1–Income tax rate)=($600,000×9%)×(1–0.36)=$54,000×0.64=$34,560
(5) Compute the number of common shares due to conversion of 9% bonds.
Numbre of common shares={Number of convertible bonds×Conversion rate}=$600,000$1,000×32 shares= 19,200 shares
(6) Compute the number of common shares due to conversion of preferred shares.
Numbre of common shares={Number of preferred shares×Conversion rate}=5,000 shares×15= 75,000
3.
Identify the amount that will be reported as basic and diluted earnings per share for the year 2019.
3.
Explanation of Solution
The Company M must report an amount of $1.95 as basic earnings per share and $1.64 as diluted earnings per share in its 2019 income statement.
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