honeycfa

Zachary Company’s warrants issued in 2000 are Zachary’s only outstanding potentially dilutive security. In 2005, EPS and Dilutive EPS differed for the first time. A possible explanation for the change is the:

A) year-end market price of Zachary increased.

B) average market price of Zachary decreased.

C) average market price of Zachary increased.

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An increase in average market price could cause Zachary’s warrants to go from antidilutive to dilutive. If the average price of the stock increases during the year, the warrants are likely to be exercised at some point during the year. Neither of the other choices would do this.

honeycfa

A company has convertible preferred stock outstanding. In the computation of diluted earnings per share, common shares issued when convertible preferred stock is converted are added to the denominator of the basic EPS equation, and the numerator is:

A) not adjusted.

B) adjusted by adding back convertible preferred stock dividends.

C) adjusted by adding back non-convertible preferred stock dividends.

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If convertible preferred stock is dilutive, the preferred dividends that would not have been paid if the preferred stock is converted must be added back to the numerator. Note that any nonconvertible preferred stock dividends are still subtracted from net income in the numerator.

honeycfa

On December 31, 2004, JME Corporation had 350,000 shares of common stock outstanding. On September 1, 2005, an additional 150,000 shares of common stock were issued. In addition, JME had $10 million of 8% convertible bonds outstanding at December 31, 2004, which are convertible into 200,000 shares of common stock. Net income for 2005 was $3 million. Assuming an income tax rate of 40%, what amount should be reported as the diluted earnings per share for 2005?

A) $5.80.

B) $5.00.

C) $6.00.

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If bonds are converted, then net income will increase by 480,000 [10 million × 0.08 × (1 ? 0.4)] and shares outstanding will increase by 200,000.

numerator = 3,000,000 + 480,000 = 3,480,000
denominator = 350,000 + (150,000 × 4/12) + 200,000 = 600,000

diluted EPS = 3,480,000 / 600,000 = 5.80

honeycfa

An analyst has gathered the following information about Zany Corp.

• Net income of $200,000 for the year ended December 31, 2004.

• During 2004, 50,000 common shares were outstanding.

• Zany has 10,000 shares of 7%, $50 par convertible preferred stock outstanding, each convertible into two shares of common.

• 5,000 warrants are outstanding with an exercise price of $24. Each warrant is convertible into one common share.

• The average market price per common share during 2004 was $20.

Calculate Zany's basic and diluted earnings per share (EPS) for 2004.

Basic EPS

Diluted EPS

A) $3.30 $2.00

B) $3.30 $2.86

C) $4.00 $2.86

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Basic EPS = (net income ? preferred dividends) / number of common shares = (200,000 ? 35,000) / 50,000 = $3.30 per share

The preferred shares are converted into 20,000 common shares, the firm does not pay preferred dividends. Diluted EPS = 200,000 / (50,000 + 20,000) = $2.86 per share. The warrants are out of the money at a stock price of $20.

honeycfa

Assume that the exercise price of an option is $5, and the average market price of the stock is $8. Assuming 816 options are outstanding during the entire year, what is the number of shares to be added to the denominator of the diluted EPS?

A) 510.

B) 816.

C) 306.

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(816)(5) = $4,080. $4,080 / $8 = 510 shares. 816 ? 510 = 306 new shares or [(8 ? 5) / 8]816 = 306.

honeycfa

The Widget Company had net income of $1 million for the period. There were 1 million shares of widget common stock outstanding for the entire period. If there are 100,000 options outstanding with an exercise price of $40, what is the diluted earnings per share for Widget common stock if the average price per share over the period was $50?

A) $1.00.

B) $0.99.

C) $0.98.

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Use the Treasury stock method
Proceeds = 100,000 ($40) = $4,000,000
Shares assumed purchased with proceeds= $4,000,000/$50 = 80,000 shares
Potential dilution = 100,000 – 80,000 = 20,000 shares
Basic EPS = $1/share
Diluted EPS = $1,000,000 / 1,020,000 = $0.98/share

honeycfa

The Gaffe Company had net income of $1,500,000. Gaffe paid preferred dividends of $5 on each of the 100,000 preferred shares. Each preferred share is convertible into 20 common shares. There are 1 million Gaffe common shares outstanding. In addition to the common and preferred stock, Gaffe has $25 million of 4% bonds outstanding. If Gaffe's tax rate is 40%, what is its diluted earnings per share?

A) $0.50.

B) $1.00.

C) $0.33.

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The preferred shares are convertible into 100,000 × 20 = 2 million common shares. They are dilutive since:

Basic EPS	=	$1,000,000	= $1.00
		1,000,000

Diluted EPS	=	$1,500,000	= $0.50 which is less.
		3,000,000

honeycfa

The Fischer Company had net income of $1,500,000. Fischer paid preferred dividends of $5 on each of the 100,000 preferred shares. There are 1 million Fischer common shares outstanding. In addition to the common and preferred stock, Fischer has $25 million of 4% bonds outstanding. The face value of each bond is $1,000. Each bond is convertible into 40 common shares. If Fischer's tax rate is 40%, determine its basic and diluted earnings per share (EPS)?

Basic EPS

Diluted EPS

A) $1.00 $1.25

B) $1.50 $1.25

C) $1.00 $0.80

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honeycfa

Assume that the exercise price of an option is $9, and the average market price of the stock is $12. Assuming 992 options are outstanding during the entire year, what is the number of shares to be added to the denominator of the Diluted EPS?

A) 744.

B) 248.

C) 992.

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(992)($9) = $8928
$8928 / 12 = 744
992 ? 744 = 248 new shares or [(12 ? 9) / 12]992 = 248

honeycfa

Assume that the exercise price of an option is $6, and the average market price of the stock is $10. Assuming 802 options are outstanding during the entire year, what is the number of shares to be added to the denominator of the diluted earnings per share (EPS)?

A) 481.

B) 802.

C) 321.

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(802)(6) = 4,812

4,812 / 10 = 481.2

802 ? 481 = 321 or [(10 ? 6) / 10] × 802 = 321