1LO 7 Compute earnings per share in a complex capital

structure.

Dirac Enterprises Example (Solution 1)Dirac Enterprises Example (Solution 1)

Compute basic & diluted earnings per share for 2007.

Revenues 17,500$

Expenses 8,400

Bond interest expense (60 x $1,000 x 8%) 4,800

I ncome bef ore taxes 4,300

I ncome taxes (40%) 1,720

Net income 2,580$

Calculation of Net Calculation of Net IncomeIncome

2LO 7 Compute earnings per share in a complex capital

structure.

Dirac Enterprises Example (solution 2)Dirac Enterprises Example (solution 2)

(a) Compute basic & diluted earnings per share for 2007.

When calculating Diluted EPS, begin with Basis EPS.

Net income = $2,580

Weighted average shares = 2,000

== $1.29$1.29

Basic EPS

3LO 7 Compute earnings per share in a complex capital

structure.

Dirac Enterprises Example (Solution 3)Dirac Enterprises Example (Solution 3)

(a) Compute basic & diluted earnings per share for 2007.

When calculating Diluted EPS, begin with Basis EPS.

$2,580

2,000 ==$.68$.68

Diluted EPS

++ $4,800 (1 - .40)

6,000

Basic EPS = 1.29

$5,460

8,000==

Effect on EPS = .48

++

==

4

Dirac Enterprises SOLUTION (a)Dirac Enterprises SOLUTION (a)

(a) Compute basic & diluted earnings per share for 2007.

Numerator Denominator EPS

Revenues 17,500 Expense 8,400 Bond interest 4,800 Pre-tax 4,300 Taxes 1,720 After tax net income 2,580 2,000 1.29$ BASIC

After tax bond interest 2,880 6,000 5,460 8,000 0.68$ Diluted

5LO 7 Compute earnings per share in a complex capital

structure.

Dirac Enterprises Example – Part bDirac Enterprises Example – Part b

Revenues 17,500$

Expenses 8,400

Bond interest expense (60 x $1,000 x 8% x 4/ 12) 1,600

I ncome bef ore taxes 7,500

I ncome taxes (40%) 3,000

Net income 4,500$

Calculation of Net Calculation of Net IncomeIncome

(b) Assume bonds were issued on Sept. 1, 2007 .

$4,500$4,500

2,0002,000== $2.25 Basic $2.25 Basic

EPSEPS

6LO 7 Compute earnings per share in a complex capital

structure.

Dirac Enterprises Example - bDirac Enterprises Example - b

(b) Assume bonds were issued on Sept. 1, 2007 .

When calculating Diluted EPS, begin with Basis EPS.

==$1.37$1.37

$1,600 (1 - .40)

6,000 x 4/12 yr.

$5,460

4,000==

Effect on EPS = .48

$4,500

2,000

Diluted EPS

Basic EPS = 2.25

++

++ ==

7

Dirac Enterprises Example – Solution bDirac Enterprises Example – Solution b

(b) Compute basic & diluted EPS for 2007 if bonds issued 9/1/07

Numerator Denominator EPS

Revenues 17,500 Expense 8,400 Bond interest 1,600 1/3 4,800$ Pre-tax 7,500 Taxes 3,000 After tax net income 4,500 2,000 2.25$ BASIC

After tax bond interest 960 2,000 5,460 4,000 1.37$ Diluted

8

Supporting ComputationsSupporting Computations

Interest Expense 60 bonds total, $1000 face value = $60,000

outstanding first half of year at 8% * 6/12 = $2,400 interest

40 bonds second half of year = $40,000 * 8% * ½ = $1,600 interest for total of $4,000 interest for year

Therefore, net income = $3,060

9

Supporting ComputationsSupporting Computations

60 bonds * 100 = 6,000 shares if converted * ½ year = 3,000 shares

40 bonds * 100 = 4,000 shares if converted * ½ year = 2,000 shares

Weighted average shares related to convertible bonds = 5,000 shares

10

Dirac Enterprises Example – Solution cDirac Enterprises Example – Solution c

(c) Compute basic & diluted EPS for 2007 if bonds issued 1/1/07 and 20 were converted on 7/1/07.

Expense 8,400 Bond interest 4,000 Pre-tax 5,100 Taxes 2,040 After tax net income 3,060 3,000 1.02$ BASIC

After tax bond interest 2,400 5,000 5,460 8,000 0.68$ Diluted

11LO 7 Compute earnings per share in a complex capital

structure.

Dancer Co. Example (similar to P16-7)Dancer Co. Example (similar to P16-7)

(a) Compute basic earnings per share for 2007.

When calculating Diluted EPS, begin with Basic EPS.

Net income $1,500,000 – Pfd. Div. $180,000*

Weighted average shares = 600,000==$2.20$2.20

Basic EPS

** 30,000 shares x $100 par x 6% = $180,000 30,000 shares x $100 par x 6% = $180,000 dividenddividend

12LO 7 Compute earnings per share in a complex capital

structure.

Dancer Co. Example (similar to P16-7)Dancer Co. Example (similar to P16-7)

When calculating Diluted EPS, begin with Basic EPS.

600,000

==

$2.00$2.00

Diluted EPS

++ $180,000

Basic EPS = 2.20

==

Effect on EPS = 1.20

(b) Compute diluted earnings per share for 2007.

$1,500,000 – $180,000

150,000*

$1,500,000

750,000

**(30,000 x 5)(30,000 x 5)

++ ==

13LO 7 Compute earnings per share in a complex capital

structure.

Dancer Co. Example – (c)Dancer Co. Example – (c)

600,000

==

$2.27$2.27

Diluted EPS

++$180,000

Basic EPS = 2.20

==

Effect on EPS = 3.00

VARIATION (c) Compute diluted earnings per share for 2007 assuming each share of preferred is convertible into 2 shares of common stock.

$1,500,000 – $180,000

60,000*

$1,500,000

660,000

**(30,000 x 3)(30,000 x 3)

++ ==

14

Dancer Co. Example – (c) SOLUTIONDancer Co. Example – (c) SOLUTION

600,000

==

$2.20$2.20

Diluted EPS

++ $180,000

Basic EPS = 2.20

==

Effect on EPS = 3.00

$1,500,000 – $180,000

60,000*

$1,320,000

600,000

**(30,000 x 3)(30,000 x 3)

Antidilutive

Basic = Diluted EPS

(c) Compute diluted earnings per share for 2007 assuming each share of preferred is convertible into 2 shares of common stock.

==++

15

Venzuela Co. Example (Stock Options)Venzuela Co. Example (Stock Options)

(a) Compute basic and diluted EPS for 2007.

Proceeds if shares issued (1,000 x $6) 6,000$

Purchase price f or treasury shares 20$

Shares assumed purchased 300

Shares assumed issued 1,000

I ncremental share increase 700

Treasury-Stock MethodTreasury-Stock Method

÷÷

1,000 shares optioned 1,000 shares optioned **

$20 - $6$20 - $6

$20 $20 = 700= 700

Short-cut formula:Short-cut formula:

16

Venzuela Co. (a) Stock OptionsVenzuela Co. (a) Stock Options

$50,000

10,000== $5.0$5.0

00

Basic EPS

$50,000

10,000==

$50,000

10,000

==$4.67$4.67

Diluted EPS

++ 700

Basic EPS = 5.00

$50,000

10,700==

Options

==

17

Venzuela Co. Example (Stock Options)Venzuela Co. Example (Stock Options)

Proceeds if shares issued (1,000 x $6) 6,000$

Purchase price f or treasury shares 20$

Shares assumed purchased 300

Shares assumed issued 1,000

I ncremental share increase 700

Weight f or 3 months assumed outstanding 3/ 12

Weighted incremental share increase 175

Treasury-Stock MethodTreasury-Stock Method

÷÷

(b) Compute diluted earnings per share assuming the 1,000 options were issued on October 1, 2007.

xx

18

Venzuela Co. Example (Stock Options)Venzuela Co. Example (Stock Options)

(b) Compute diluted earnings per share assuming the 1,000 options were issued on October 1, 2007.

$50,000

10,000== $4.91$4.91

Diluted EPS

++ 175

Basic EPS = 5.00

$50,000

10,175==

Options

19

Wilke Corp ExampleWilke Corp Example

Weighted-Average Number of SharesWeighted

Change in Shares Fraction 10% 3/1 AverageDate Shares Outstanding of Year Dividend Split Shares

Jan. 1 480,000 x 1/12 x 110% x 3 132,000 Feb. 1 120,000 600,000 x 1/12 x 110% x 3 165,000 Mar. 1 60,000 660,000 x 2/12 x 3 330,000 May 1 (100,000) 560,000 x 1/12 x 3 140,000 June 1 3/1 split 1,680,000 x 4/12 x 560,000 Oct. 1 60,000 1,740,000 x 3/12 x 435,000

1,762,000 Divide 12

146,833