Reading 32: Understanding the Income Statement-LOS h 习题精选 2011, between, discuss, center, style

1215

Session 8: Financial Reporting and Analysis: The Income Statement, Balance Sheet, and Cash Flow Statement
Reading 32: Understanding the Income Statement

LOS h: Differentiate between dilutive and antidilutive securities, and discuss the implications of each for the earnings per share calculation.

 

 

Moulding Company’s net income was $13,820,000 with 2,600,000 shares outstanding. The average share price for the year was $58.00. Moulding had 10,000 options to purchase 10 shares each at $40 per share outstanding the entire year. Moulding Company’s diluted earnings per share are closest to:

A) $3.71.

B) $5.32.

C) $5.25.

---

 

Moulding’s basic EPS (net income / weighted average common shares outstanding) was $13,820,000 / 2,600,000 = $5.32.

Using the treasury stock method to compute diluted EPS, if the options were exercised, cash inflow would be 10,000 × 10 × $40 = $4,000,000. Based on the average share price of $58.00, the number of Moulding shares that can be purchased with the cash flow is $4,000,000 / $58 = 68,966. The number of shares that would have been created is 100,000 – 68,966 = 31,034. Diluted EPS was $13,820,000 / (2,600,000 + 31,034) = $5.25.

1215

Valuable Corp.’s basic earnings per share (EPS) and diluted EPS for the year are different. Given this information, which of the following statements is least accurate?

A) All of Valuable's potentially dilutive securities are antidilutive.

B) Diluted EPS is less than basic EPS.

C) Valuable Corp.'s capital structure may include both options and warrants.

---

If all of Valuable’s potentially dilutive securities were antidilutive, then EPS would equal diluted EPS.

1215

An analyst compiled the following information from Hampshire, Inc.’s financial activities in the most recent year:

• Net income was $2,800,000.
• 100,000 shares of common stock were outstanding on January 1.
• The average market price per share for the year was $250.
• 10,000 shares of 6%, $1,000 par value preferred shares were outstanding the entire year.
• 10,000 warrants, which allow the holder to purchase 10 shares of common stock for each warrant held at a price of $150 per common share, were outstanding the entire year.
• 30,000 shares of common stock were issued on September 1.

Hampshire, Inc.’s diluted earnings per share are closest to:

A) $18.38.

B) $14.67.

C) $20.00.

---

To compute Hampshire’s basic EPS ((net income – preferred dividends) / weighted average common shares outstanding), the weighted average common shares must be computed. 100,000 shares were outstanding from January 1, and 30,000 shares were issued on September 1, so the weighted average is 100,000 + (30,000 × 4 / 12) = 110,000. Basic EPS is ($2,800,000 – (10,000 × $1,000 × 0.06)) / 110,000 = $20.00.

If the warrants were exercised, cash inflow would be 10,000 × $150 × 10 = $15,000,000 for 10 × 10,000 = 100,000 shares. Using the treasury stock method, the number of Hampshire shares that can be purchased with the cash inflow (cash inflow / average share price) is $15,000,000 / $250 = 60,000. The number of shares that would be created is 100,000 – 60,000 = 40,000. Diluted EPS is $2,200,000 / (110,000 + 40,000) = $14.67.

1215

Selected information from Feder Corp.’s financial activities for the year is as follows:

• Net income was $7,650,000.

• 1,100,000 shares of common stock were outstanding on January 1.

• The average market price per share was $62.

• Dividends were paid during the year.

• The tax rate was 40%.

• 10,000 shares of 6% $1,000 par value preferred shares convertible into common shares at a rate of 20 common shares for each preferred share were outstanding for the entire year.

• 70,000 options, which allow the holder to purchase 10 shares of common stock at an exercise price of $50 per common share, were outstanding the entire year.

Feder Corp.’s diluted earnings per share (EPS) was closest to:

A) $5.87.

B) $5.32.

C) $4.91.

---

Feder’s basic earnings per share ((net income – preferred dividends) / weighted average shares outstanding) was (($7,650,000 – ($1,000 × 10,000 × 0.06)) / 1,100,000 =) $6.41.

If the convertible preferred stock was converted to common stock at January 1, (10,000 × 20 =) 200,000 additional common shares would have been issued, dividends on the preferred stock would not have been paid, and Diluted EPS would have been ($7,650,000 / (1,100,000 + 200,000) = $5.88. Because $5.88 is less than basic EPS of $6.41, the preferred shares are dilutive.

Using the treasury stock method, if the options were exercised cash inflow would be (70,000 × 10 × $50 =) $35,000,000. The number of Feder shares that can be purchased with the inflow (cash inflow divided by the average share price) is ($35,000,000 / $62 =) 564,516.

The number of shares that would have been created is (700,000 – 564,516 =) 135,484. Diluted EPS was ($7,650,000 / (1,100,000 + 135,484) =) $6.19. Because this is less than the EPS of $6.41, the options are dilutive.

Combining the calculations, Diluted EPS was (($7,650,000) / (1,100,000 + 200,000 + 135,484) = $5.32.

1215

 

In applying the treasury stock method, if warrants allow the purchase of 1 million shares at $42 per share when the average price is $56 per share, how many shares will be added to the firm’s weighted average number of shares outstanding?

A) 1,000,000.

B) 250,000.

C) 420,000.

---

 

The treasury stock method would allow the 1 million additional shares to be partially offset by the number of shares that could be repurchased with the amount of money received for those shares. In this case, the 1 million shares issued would be offset by (1,000,000 × $42 / $56) or 750,000 shares.

1215

Cassie Hamilton is an analyst with Pacers Worldwide, an investment banking firm. She just received the following information (as of year-end) for Trotters Diversified:

• Average common shares outstanding of 5.0 million.
• Average market price for common stock of $35.00 per share.
• Net income of $9.0 million.
• Common stock dividends paid of $1.2 million.
• Preferred dividends paid (on convertible preferred stock noted below) of $1.5 million.
• Tax rate of 40%.
• 500,000 shares of cumulative convertible preferred stock with $30 par value and 10% dividend. Each preferred share is convertible into 5 common shares.
• 10,000 convertible $1,000 par bonds with a 6.0% coupon, each convertible into 8 shares of common stock.
• 400,000 stock options recently issued with an exercise price of $32.00 per share.

In the denominator of the basic EPS calculation, Hamilton should include how many shares related to the convertible bonds?

A) 80,000.

B) 10,000.

C) 0.

---

The calculation for basic EPS excludes the impact of complex capital elements.

---

Hamilton correctly calculates diluted EPS at approximately:

A) $1.19.

B) $1.23.

C) $1.50.

---

As we will show below, only the options and convertible preferred stock are dilutive.

First, calculate basic EPS to use as a benchmark to determine dilutive capital components.
Basic EPS = (net income – preferred dividends) / weighted average common shares outstanding
Here, preferred dividends = (0.5 shares × $30 par × 0.10 dividend) = $1.5 million = (9.0 – 1.5) / 5.0 = $1.50.

Now, check for dilutive elements.

• options are dilutive because the exercise price is less than the stock price. There is no numerator impact from the options. The denominator impact = # options – [(# options × exercise price) / average stock price)] = 400,000 – [(400,000 × 32) / 35] = 34,286 or 0.034 million.

• To check whether the convertible preferred stock is dilutive we need to determine whether it decreases EPS. To the numerator, we add back the preferred dividend. The denominator impact = (# preferred shares × conversion rate) = 500,000 × 5 = 2,500,000, or 2.5 million. Then, EPS = (9.0 – 1.5 + 1.5) / (5.0 + 2.5) = $1.20. Thus the convertible preferred stock is dilutive.

• To check whether the convertible bonds are dilutive we need to determine whether they decrease EPS. To the numerator, we add back the after-tax impact of the coupon, or (face value × coupon × (1 ? t)), or (10,000 bonds × 1,000 par × 0.06 coupon × 0.6 ) = 360,000, or $0.360 million. The denominator impact = (# convertible bonds × conversion rate) = 10,000 × 8 = 80,000, or 0.080 million. Then, EPS = (9.0 – 1.5 + 0.360) / (5.0 + 0.080) = $1.55. Thus the bonds are antidilutive.

Finally, calculate dilutive EPS:
Diluted EPS = (9.0 – 1.5 + 1.5) / (5.0 + 2.5 + 0.034) = approximately $1.19

1215

All of the following are considered a potentially dilutive securities EXCEPT:

A) preferred stock.

B) stock options.

C) warrants.

---

Not all preferred stock is dilutive. Only convertible preferred stock is potentially dilutive.

1215

Examples of potentially dilutive securities include all of the following EXCEPT:

A) non-convertible bonds.

B) convertible preferred stock.

C) options.

---

Preferred stock and bonds are only considered to be potentially dilutive if they are convertible. Options are always considered to be potentially dilutive.

1215

When calculating earnings per share (EPS) for firms with complex capital structures, stock options are ordinarily considered to be:

A) potentially dilutive securities.

B) antidilutive securities.

C) derivative securities.

---

Dilutive securities are securities that decrease EPS if they are exercised or converted to common stock. When the exercise price is less than the average market price, stock options are considered to be dilutive, Stock options, warrants, convertible debt, and convertible preferred stock are examples of potentially dilutive securities.

1215

When calculating earnings per share (EPS) for firms with complex capital structures, convertible bonds are ordinarily considered to be:

A) embedded debt securities.

B) antidilutive securities.

C) potentially dilutive securities.

---

Dilutive securities are securities that decrease EPS if they are exercised or converted to common stock. Stock options, warrants, convertible debt, and convertible preferred stock are examples of potentially dilutive securities. Note that if diluted EPS when considering the convertible bonds is greater than basic EPS, the convertible bonds would be antidilutive and should not be treated as common stock in computing diluted EPS.