Required:
Compute Jackson's basic and diluted earnings per share for 2006.
Answer:
Basic EPS
[$180,905 - (7% x $50 x 30,000]/[100,000 - (24,000 x 10/12) + (6,000 x 3/12] = $.93 EPS
Diluted EPS
Since the exercise price is greater than the average price on the open market, the stock options are antidilutive. Therefore, only basic EPS is presented. The existence of the options is disclosed in the footnotes.
Learning Objective: 9 Level of Learning: 3
141. On December 31, 2005, Jackson Company had 100,000 shares of common stock outstanding and 30,000 shares of 7%, $50 par, cumulative preferred stock outstanding. On February 28, 2006, Jackson purchased 24,000 shares of common stock on the open market as treasury stock paying $45 per share. Jackson sold 6,000 of the treasury shares on September 30, 2006, for $47 per share. Net income for 2006 was $180,905. Also outstanding at December 31, 2005, were stock options giving key personnel the option to buy 50,000 common shares at $40. These stock options were exercised on November 1, 2006. During 2006, the average market price of the common shares was $50 with a closing price of $51 on December 31, 2006.
Required:
Compute Jackson's basic and diluted earnings per share for 2006.
Answer:
Basic EPS
[$180,905 - (7% x $50 x 30,000]/[100,000 - (24,000 x 10/12) + (6,000 x 3/12) + (50,000 x 2/12)] = $.84 EPS
Diluted EPS
[$180,905 - (7% x $50 x 30,000)]/[(100,000 - (24,000 x 10/12) + (6,000 x 3/12) + ({50,000 - 40,000*} x 10/12) + (50,000 x 2/12)] = $.77EPS
*(50,000 x $40)/$50 = 40,000
Learning Objective: 9 Level of Learning: 3
142. On December 31, 2005, Heffner Company had 100,000 shares of common stock outstanding and 30,000 shares of 7%, $100 par, cumulative preferred stock outstanding. On February 28, 2006, Heffner purchased 24,000 shares of common stock on the open market as treasury stock paying $45 per share. Heffner sold 6,000 of the treasury shares on September 30, 2006, for $47 per share. Net income for 2006 was $540,000. The income tax rate is 40%. Also outstanding at December 31, 2005, were stock options giving key personnel the option to buy 50,000 common shares at $40. During 2006, the average market price of the common shares was $50 with a closing price of $51 on December 31, 2006. Five thousand 6% bonds were issued at par on January 1, 2006. Each $1,000 bond is convertible into 125 shares of common stock. None of the bonds had been converted by December 31, 2006 and no stock options were exercised during the year.
Required:
Compute basic and diluted earnings per share for Heffner Company for 2006.
Answer:
Basic EPS
[$540,000 - (7% x $100 x 30,000)]/[(100,000 - (24,000 x 10/12) + (6,000 x 3/12) = $4.05 EPS
Diluted EPS
[$540,000 - (7% x $100 x 30,000) + ((5,000 x $1,000 x 6% x 60%)]/
[(100,000 - (24,000 x 10/12) + (6,000 x 3/12) + (50,000 - 40,000*)
+ (5,000 x 125) = $0.71 EPS
*(50,000 x $40)/$50 = 40,000
Learning Objective: 9 Level of Learning: 3
143. Stock options for 100,000 shares of common stock at an exercise price of $50 were outstanding for the entire year. The average market price of the stock was $56 and the end-of-year price was $55.
Required:
By how many shares will the assumed exercise of these options increase the weighted-average number of shares outstanding when calculating diluted earnings per share?
Answer:
100,000 - [(100,000 x $50 / $56)] = 10,714 shares
Learning Objective: 9 Level of Learning: 3
144. Stock options for 60,000 shares of common stock at an exercise price of $50 were outstanding at the beginning of 2006. The average market price of the stock was $56 and the end-of-year price was $55.
Required:
If these options are exercised on March 1 of the current year, by how many shares will the options increase the weighted-average number of shares outstanding when calculating diluted earnings per share?
Answer:
[(60,000 – 53,571*) x 2/12)] + (60,000 x 10/12) = 51,072 shares
**(60,000 x $50/$56) = 53,571
Learning Objective: 9 Level of Learning: 3
145. XYZ Company had 200,000 shares of common stock outstanding on December 31, 2005. On July 1, 2006, XYZ issued an additional 50,000 shares for cash. On January 1, 2006, XYZ issued 20,000 shares of convertible preferred stock. The preferred stock had a par value of $100 per share and paid a 5% dividend. Each share of preferred stock is convertible into 8 shares of common. During 2006, XYZ paid the regular annual dividend on the preferred and common stock. Net income for the year was $300,000.
Required:
Calculate XYZ's basic and diluted earnings per share for 2006.
Answer:
Basic
[$300,000 - ($100 x 5% x 20,000)]/[(200,000 + (50,000 x 6/12)] = $.89 EPS
Diluted
$300,000 /[(200,000 + (50,000 x 6/12) + (20,000 x 8)] = $.78 EPS
Learning Objective: 7 Level of Learning: 3
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146. Paul Company had 100,000 shares of common stock outstanding on January 1, 20063. On September 30, 2006, Iceland sold 48,000 shares of common stock for cash. Paul also had 10,000 shares of convertible preferred stock outstanding throughout 2006. The preferred stock is $100 par, 6%, and is convertible into 3 shares of common for each share of preferred. Paul also had 500, 8%, convertible bonds outstanding throughout 2006. Each $1,000 bond is convertible into 30 shares of common stock. The bonds sold originally at par. Reported net income for 2006 was $300,000 with a 40% tax rate. The regular common and preferred dividends were paid in 2006.
Required:
Compute basic and diluted earnings per share for 2006.
Answer:
Basic
[$300,000 - (6% x $100 x 10,000)]/[(100,000 + (48,000 x 3/12)] = $2.14 EPS
Diluted
[$300,000 + ($500,000 x 8% x 60%*)]/[(100,000 + (48,000 x 3/12) + (10,000 x 3) +
(500 x 30)) = $2.06 EPS
*1- 40% = 60%
Learning Objective: 10 Level of Learning: 3
147. Woolery, Inc. had 50,000 shares of common stock outstanding at January 1, 2006. On March 31, 2006, an additional 12,000 shares were sold for cash. Woolery also had $4,000,000 of 6% convertible bonds outstanding throughout the year. The bonds are convertible into 40,000 shares of common stock. Net income for the year was $350,000. The tax rate is 35%.
Required: Compute basic and diluted earnings per share for the year ended December 31, 2006.
Answer:
Basic
$350,000 /[(50,000 + (12,000 x 9/12)] = $5.93 per share
Diluted
[$350,000 + ($4M x 6% x 65%)]/[(50,000 + (12,000 x 9/12) + 40,000)] = $5.11 per share
Learning Objective: 10 Level of Learning: 3
148. On December 31, 2005, Merlin Company had outstanding 400,000 shares of common stock and 40,000 shares of 8% cumulative preferred stock (par $10). On February 28, 2006, Merlin issued an additional 36,000 shares of common stock. On September 1, 2006, 9,000 shares were retired. At year-end, there were executive stock options outstanding for 30,000 shares of common stock (adjusted for the stock dividend). The exercise price was $18. The market price of the common stock during the year had averaged $20. Also outstanding were $1,000,000 face amount of 10% convertible bonds issued in 2003 and convertible into 50,000 common shares (adjusted for the stock dividend). Net income was $900,000. The tax rate for the year was 40%. A 10% stock dividend was declared and distributed on July 1, 2006.
Required:
Compute basis and diluted EPS for the year ended December 31, 2006.
Answer:
Basic EPS = ($ in 000s, except per share amount)
Diluted EPS
Shares Reacquired for Diluted EPS
-
30
thousand shares
x
$ 18
(exercise price)
$540
thousand
÷
$ 20
(average market price)
27
thousand shares reacquired
Learning Objective: 9 Level of Learning: 3
149. During 2006, Quattro entered into the following transactions relating to shareholders' equity. The corporation was authorized to issue 20 million common shares, $1 par per share.
Net income for 2006 was $110 million.
-
Jan. 2:
Issued 10 million common shares for cash.
Jan. 3:
Entered an agreement with the company president to issue up to 2 million additional shares of common stock in 2006 based on the earnings of Quattro in 2006. If net income exceeds $100 million, the president will receive 1 million shares; 2 million shares if net income exceeds $120 million.
Required:
Compute basic and diluted EPS for 2006.
Answer:
(amounts in millions, except per share amounts)
Basic EPS
Diluted EPS
Because the conditions are met for issuing 1 million shares, those shares are assumed issued for diluted EPS. Conditions for the other 1 million shares are not yet met, so they are ignored.
Learning Objective: 11 Level of Learning: 3
Essay
Instructions:
The following answers point out the key phrases that should appear in students' answers. They are not intended to be examples of complete student responses. It might be helpful to provide detailed instructions to students on how brief or in-depth you want their answers to be.
150. Compare the concepts of basic and diluted earnings per share.
Answer: Basic earnings per share is simply the current year's net income (or loss) minus preferred stock dividends if any, (the numerator), divided by the weighted-average common shares outstanding for the year (the denominator). The diluted earnings per share computation also includes the dilutive effects of potential common shares in the denominator of the fraction providing the maximum possible dilution if all potential common shares are converted into common stock.
Learning Objective: 12 Level of Learning: 2
151. How is a complex capital structure different from a simple capital structure?
Answer: A complex capital structure is one that includes convertible securities and/or rights, options, or warrants that would have a potential dilutive effect on earnings per share if converted or exercised. In a simple capital structure, the company only has common stock or common stock along with nonconvertible preferred stock as the only securities outstanding with no potential common shares.
Learning Objective: 5 Level of Learning: 1
152. Why are earnings per share figures for prior years adjusted for stock splits and stock dividends when data from prior years is presented in comparative financial statements?
Answer: When a company has a stock split or issues a stock dividend, the number of shares of common stock outstanding is increased with no increase in the resources of the corporation. If one is to compare the earnings per share figure of the current period with that of any periods shown for comparative purposes, then the stock split or stock dividend must be reflected in the EPS data for all years presented in the comparative statements.
Learning Objective: 7 Level of Learning: 2
153. What is the treasury stock method of accounting for stock options, warrants, and rights?
Answer: The treasury stock method is a way of determining the extent of dilution of earnings per share due to stock options, stock rights, and stock purchase warrants. Under the treasury stock method, options, rights, and warrants are treated as if they were exercised at the beginning of the year. The funds that would come into the firm from the assumed exercise of options, rights, and warrants are assumed to be used to reacquire shares of common stock (treasury stock) at the average market price of the stock for the year.
Learning Objective: 9 Level of Learning: 1
154. What is meant by dilution of earnings per share?
Answer: Dilution refers to the effect that convertible securities and rights such as options, stock rights, and stock purchase warrants could have on basic earnings per share if these securities were exchanged for common stock. If the exercise of the security would reduce earnings per share to a level below basic earnings per share, then the effect on EPS is dilutive. Dilution can only occur in a firm with a complex capital structure.
Learning Objective: 10 Level of Learning: 1
155. What is the "if converted method"?
Answer: The "if converted method" is used to assume conversion of any convertible preferred stock or convertible bonds outstanding at year-end into common stock. By assuming conversion of preferred stock, the numerator of the basic earnings per share computation is increased by the preferred dividends while the denominator is increased by the number of shares of common stock represented by the convertible preferred stock. By assuming conversion of convertible bonds, the numerator of the basic earnings per share computation is increased by the current year's bond interest (net of tax) while the denominator is increased by the number of common shares represented by the convertible bonds.
Learning Objective: 10 Level of Learning: 1
156. Why are preferred dividends deducted from net income when calculating EPS?
Answer: Preferred dividends are deducted from the numerator in the EPS fraction so that "earnings available to common shareholders" can be divided by the weighted-average common shares outstanding. This is done because preferred shareholders normally receive dividends before common shareholders are entitled to receive any distribution from the company. This is one of the preferences that make preferred stock attractive to certain investors.
Learning Objective: 8 Level of Learning: 2
157. When the income statement includes separately reported items such as discontinued operations or extraordinary items, which amounts require per share presentation?
Answer: EPS data (basic and diluted) must be presented on the face of the income statement for net income. EPS for these "below the line items" would be reported either on the face of the income statement or through footnote disclosure.
Learning Objective: 12 Level of Learning: 1
158. What is an antidilutive security?
Answer: An antidilutive security is one whose terms permit it to be converted into common stock, but if it were converted, EPS would increase rather than decrease. If a loss is reported for the year, it would decrease rather than increase the loss per share. If a convertible security or right to stock is antidilutive, it is ignored in the EPS computations. Although ignored in the calculation of EPS, such securities must still be disclosed in the footnotes.
Learning Objective: 10 Level of Learning: 2
159. Magnetek, Inc. supplies digital power-electronic products used in information technology and industrial, communications, consumer and other markets. In its 2001 Annual Report to Shareholders, Magnetek, Inc. disclosed the following footnote about its EPS:
"The consolidated financial statements are presented in accordance with SFAS No. 128, "Earnings Per Share." Basic earnings per share are computed using the weighted average number of common shares outstanding during the period. Diluted earnings per common share incorporate the incremental shares issuable upon the assumed exercise of stock options and upon the assumed conversion of the Company's Convertible Notes in fiscal 2001 as if conversion to common shares had occurred at the beginning of the fiscal year. Earnings have also been adjusted for interest expense on the Convertible Notes in fiscal 2001."
Explain why Magnetek mentioned the adjustment in the last sentence of the footnote.
Answer: In determining its diluted EPS, Magnetek assumed conversion of its notes into common stock. In this hypothetical case, the notes would disappear, as would the interest cost on them. Thus, by assuming conversion, the diluted EPS denominator is increased and, correspondingly, the interest expense is eliminated from net income in the numerator.
Learning Objective: 10 Level of Learning: 2
Use the following to answer questions 160-161: