Example 1 - Basic EPS

SOLUTION

JKL Corp. reported net income of $1,000,000 for 2010. The tax rate was 40%. As of 1/1/10, 200,000 shares of common stock were outstanding. On 6/1/10 30,000 new shares were sold. There are no potentially dilutive securities outstanding but JKL has 2,000 shares of 8% cumulative preferred stock ($10 par) which was outstanding all year. Simple capital structure - only BASIC is reported Find the WA common All year 1-Jun WA Common Preferred dividends $ 200,000 12/12 30,000 7/12 200,000 17,500 217,500 $10 8% $0.80

2000 shares $0.80 1,600.00 dividend =

Net income Pfd dividends

Numerator Denominator $ 1,000,000 217,500 $ (1,600.00) $ 998,400 217,500

per share

4.59 BASIC

is reported

par

EPS EXAMPLE #2 WHAT IF METHOD - CONVERTIBLE PREFERRED

JKL Corp. reported net income of $1,000,000 for 2010. The tax rate was 40%. As of 1/1/10, 200,000 shares of common stock were outstanding. On 6/1/10 30,000 new shares were sold. There are no potentially dilutive securities outstanding but JKL has 2,000 shares of 8% cumulative preferred stock ($10 par) which was outstanding all year.

Same as #1 except:

JKL also has an issue of convertible preferred stock (cumulative) that was outstanding during the entire year. The preferred stock has a $100 par value and pays a $10 annual dividend. The 5,000 shares were outstanding all year. Each share of preferred stock can be converted into 5 shares of common stock.
WA common stock from #1 Preferred dividend (nonconvertible) from #1 Preferred dividend - convertible shares= 5000 Dividend per share $ 10.00 $ 50,000.00 217,500 index= $ 50,000.00 $ 1,600.00 25,000 $ 50,000.00 $ 2.00 5 shares conversion ratio 25,000 more shares if converted

Less Less

Net income Nonconv pfd dividend Conv pfd dividend

If converted

Numerator Denominator per share $ 1,000,000 217,500 $ 1,600 $ 50,000.00 $ 948,400 217,500 4.36
$ 50,000.00 $ 998,400 25,000 242,500 4.12

BASIC
Diluted EPS

Example 3 - What If Method with a Convertible Bond

JKL Corp. reported net income of $1,000,000 for 2010. The tax rate was 40%. As of 1/1/10, 200,000 shares of common stock were outstanding. On 6/1/10 30,000 new shares were sold. There are no potentially dilutive securities outstanding but JKL has 2,000 shares of 8% cumulative preferred stock ($10 par) which was outstanding all year. JKL also has an issue of convertible preferred stock (cumulative) that was outstanding during the entire year. The preferred stock has a $100 par value and pays a $10 annual dividend. The 5,000 shares were outstanding all year. Each share of preferred stock can be converted into 5 shares of common stock.

Same as #1 and #2 except:

JKL also has $3,000,000 in convertible bonds outstanding all year. The bonds were sold at face value and pay 6% interest semi-annually. Each $1000 bond can be converted into 50 shares of common stock.
If bonds are converted How many bonds? Face value of one bond Number of bonds = Conversion ratio = Additional shares CS if converted Numerator effect = AFTER-TAX interest expense Computed as interest expense * (1 - tax rate) Face value of all bonds= $ 3,000,000 Annual rate (issued at face) 6% Interest paid (and expense) $ 180,000 times (1-t) Tax rate = 40% Tax deduction $ 72,000 Net of tax = $ 108,000 $ $ 3,000,000 face 1,000.00 3,000 50 shares per bond 150,000

Index = numerator effect divided by the denominator effect 108,000.00 numerator 150,000 denom index= 0.72 $

Net income Nonconv pfd dividend Conv pfd dividend Same as #2 so far Conv bond Conv pfd

Numerator Denominator per share $ 1,000,000 $ (1,600) $ (50,000) $ 948,400 217,500 $ $ 108,000 150,000 $ 1,056,400 367,500 50,000 25,000 $ 1,106,400 392,500

4.36 BASIC 2.87 2.82 DILUTED EPS

EPS EXAMPLE #4 TREASURY STOCK METHOD - STOCK OPTIONS

(Same as #1) JKL Corp. reported net income of $1,000,000 for 2010. The tax rate was 40%. As of 1/1/10, 200,000 shares of common stock were outstanding. On 6/1/10, 30,000 new shares were sold. JKL has 2,000 shares of 8% cumulative preferred stock ($10 par) which was outstanding all year.

JKL Corp. also 40,000 stock options outstanding all year. At any time during the next five years, the option holders have the right to buy a share of common stock for $10 per share. The average market price during 2010 was $40 and the year-end closing price was $45 per share. WA common stock (from #1) Preferred dividend (from #1)
treasury stock method procedures Compute amount of cash that would be received if all the stock options or warrants were 1 exercised. Compute the number of shares that could be purchased with the cash amount from step 1 using 2 average market price for period Compute the number of NET new shares - subtract the number acquired (step 2) from the total 3 number of options or warrants that would be exercised (step 1).

217,500 1,600.00

Step 1 $ $

40,000 options Exercise price $10 each 10 exercise price 400,000 CASH $ equals 400,000 $40 Average Mkt Price 10,000 Treasury stock that could be purchased

Step 2 - use cash to buy TS

Step 3

40,000 common issued (10,000) less treasury stock purchased 30,000 net new shares of common

shortcut method

net new shares

see formula in "doc" notes file 40,000 options times 40 -10 40 40,000 times 0.75 =

30,000 net new shares

Net income Pfd dividend Effect of options

Numerator Denominator per share $ 1,000,000 $ (1,600) $ 998,400 217,500 4.59 Basic $ 30,000 $ 998,400 247,500 4.03 Diluted

Earnings Per Share Example #5 Weighted Average Shares To Nearest Month

CONSIDER THE FOLLOWING TRANSACTIONS IN COMMON STOCK:

Common shares outstanding Jan 1 to Feb 28 March 1, new shares sold Shares outstanding Mar 1 to April 30 May 1, 100% stock dividend issued Shares outstanding May 1 to Oct 31 Nov 1, acquired treasury stock Shares outstanding Oct 31 to Nov 30 Dec 1, re-issued treasury stock Shares outstanding Dec 1 to Dec 31

20,000 1,000 21,000 21,000 42,000 -2,000 40,000 1,000 41,000

Dates

Actual Shares Outstanding

Retroactive Stock Splits & Dividends

Months Outstanding

Weighted shares Outstanding

Jan1 to Feb 28 March 1 to Apr 30 May 1 to Oct 31 Nov 1 to Nov 31 Dec 1 to Dec 31

20,000 21,000 42,000 40,000 41,000

2 2 1 1 1

2 2 6 1 1 12

Weighted average shares of common stock

80,000 84,000 252,000 40,000 41,000 497,000 41,417 divide by 12

Example 6 - EPS Weighted Average Shares

CONSIDER THE FOLLOWING TRANSACTIONS IN COMMON STOCK:

Issued Common shares outstanding Jan 1 to Feb 28 March 1, treasury stock sold Shares outstanding Mar 1 to May 31 Jun 1, new shares issued Shares outstanding Jun 1 to Aug 31 Sep 1, acquired treasury stock Shares outstanding Sep 1 to Oct 31 Nov 1, 200% stock dividend issued Shares outstanding Nov 1 to Dec 31 100,000
0

Shares in Treasury 5,000 -1,000 4,000 4,000 2,000 6,000 6,000

Outstanding 95,000 1,000 96,000 20,000 116,000 -2,000 114,000 228,000 342,000

100,000 20,000 120,000 0 120,000 228,000 348,000

Actual Shares Dates Outstanding

Retroactive Stock Splits & Dividends

Months Outstanding

Weighted shares Outstanding

Jan 1 to Feb 28 Mar 1 May 31 Jun 1 Aug 31 Sep 1 to Oct 31 Nov 1 to Dec 31 WA shares of common stock

95,000 96,000 116,000 114,000 342,000

3 3 3 3 1

2 3 3 2 2 12

570,000 864,000 1,044,000 684,000 684,000 3,846,000 320,500

Detailed computations for each potentially dilutive security

A. 9.5% preferred stock $2,000,000 par value. Issued at 112. Each $100 par preferred stock is convertible into 5 total par value divided by par value per share $ 2,000,000.00 $100 par ea 20,000 shares of pfd 5 conversion ratio 100,000 denominator effect more shares of common if converted Divdend 9.50% shares = Dividend = INDEX = $190,000.00 100,000 $9.50 20,000 $190,000.00 1.90

B. 8.0% preferred stock $1,500,000 par value. Issued at par. Each $100 par preferred stock is convertible into 3 shares 1,500,000 100 par 15,000 shares of pfd 3 conversion ratio 45,000 common shares if converted 8% $ dividend = $ 8.00 15,000 120,000.00

INDEX = $

120,000.00 45,000

2.67

C. 50,000 options The options were issued last year with an exercise price of $15. The average market price for options 1. Proceeds from exercise 2. Buy TS at avg mkt price exercise price 50,000 $ 15.00 $

750,000

mkt= $ 35.00 divided into proceeds = Number of shares of TS we could buy with the proceeds 50,000 (21,429) 28,571 0 no numerator effect 28,571

21,429

3. Shares issued in step 1 less TS purchased in step 2 Net new shares = denominator impact INDEX

D. 8.0% bonds Face value of $5,000,000. Bonds were issued at a discount. Because the impact was material, $ $ 5,000,000.00 1,000.00 5,000 50 250,000 Face value total face value each number of bonds Conversion ratio common if converted 4% Int pd 1-Jan Jun-10 $ 31-Dec $ 200,000.00 $ 200,000.00 $ $ int exp 239,176.30 $ INDEX $ 336,217.99 250,000 $ 1.34

Interest * (1-t) 5% amort

336,217.99

balance $ 4,783,526 39,176.30 $ 4,822,702.30

241,135.12 $ 41,135.11 $ 4,863,837.42 480,311.42 interest expense for the year 30% Less taxes

E. 9% bonds Face value of $5,000,000. Bonds were issued at 101. Since the premium was not material, the

$ $

5,000,000.00 5,000.00 1000 150 150,000

total face How much is premium? face value each Issue price bonds Premium = conversion ratio common shares issued if converted amortize per year Interest paid 9% Subtract a premium Int expense Add a discount Times (1-t) AFTER TAX INT Index $ 313,250.00 150,000

$ $ $ $ $ $

1.01 5,050,000.00 50,000.00 20 years 2,500.00 450,000.00 447,500.00 70% 313,250.00 2.09

Summary List from smalles to largest Item C options Bonds D Pfd A Bonds E Pfd B numerator effect denominator effect $ 28,571 $ 336,218.00 250,000 $ 190,000.00 100,000 $ 313,250.00 150,000 $ 120,000.00 45,000 INDEX $ $ $ $ $ 1.34 1.90 2.09 2.67

Worksheet for Example #7

Assume net income for the year was $1,585,000 and the weighted average shares of common stock
NUMERATOR DENOMINATOR EPS

Net income Pfd A Pfd B Smallest to largest Options

$1,585,000 (190,000.00) (120,000.00) $1,275,000

500,000

500,000.00

2.55

BASIC

28,571.00 $1,275,000 528,571.00 Bonds D 336,218.00 250,000.00 1,611,218.00 778,571.00 Pfd A 190,000.00 100,000.00 1,801,218.00 878,571.00 stop because next item is LARGER than latest EPS Bonds E 313,250.00 150,000.00 2,114,468.00 1,028,571.00

2.41 2.07 2.05

EPS1

DILUTED

2.06

starts going back up