clearlycanadian

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) $0.98.

B) $1.00.

C) $0.99.

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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

clearlycanadian

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) $1.00.

B) $0.33.

C) $0.50.

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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.

clearlycanadian

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) $1.00 $0.80

C) $1.50 $1.25

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clearlycanadian

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) 248.

B) 744.

C) 992.

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

clearlycanadian

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) 321.

C) 802.

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(802)(6) = 4,812
4,812 / 10 = 481.2
802 − 481 = 321 or [(10 − 6) / 10] × 802 = 321

clearlycanadian

Assume that the exercise price of an option is $10, and the average market price of the stock is $13. Assuming 999 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) 768.

B) 999.

C) 231.

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(999)(10) = 9,990
9,990 / 13 = 768
999 − 768 = 231

clearlycanadian

Assume that the exercise price of an option is $11, and the average market price of the stock is $16. Assuming 1,039 options are outstanding during the entire year, what is the number of shares to be added to the denominator of the Diluted EPS?

A) 325.

B) 714.

C) 1,039.

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(1,039 options)($11) = $11,429
$11,429 / $16 per share
1039 − 714 = 325 shares or [(16 − 11) / 16]1,039 = 325.

clearlycanadian

The following data pertains to the Sapphire Company:

• Net income equals $15,000.
• 5,000 shares of common stock issued on January 1st.
• 10% stock dividend issued on June 1st.
• 1,000 shares of common stock were repurchased on July 1st.
• 1,000 shares of 10%, $100 par preferred stock each convertible into 8 shares of common were outstanding the whole year.

What is the company’s diluted earnings per share (EPS)?

A) $2.50.

B) $1.00.

C) $1.15.

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Number of average common shares:
1/1 5,500 shares issued (includes 10% stock dividend on 6/1) × 12 = 66,000
7/1 1,000 shares repurchased × 6 months = -6,000
= 60,000
60,000 shares / 12 months = 5,000 average shares
Preferred dividends = ($10)(1,000) = $10,000
Number of shares from the conversion of the preferred shares = (1,000 preferred shares)(8 shares of common/share of preferred) = 8,000 common
Diluted EPS = [$15,000(NI) − $10,000(pfd) + $10,000(pfd)] / 5000(common shares) + 8000(shares from the conv. pfd. shares) = $15,000 / 13,000 shares = $1.15/share
This number needs to be compared to basic EPS to see if the preferred shares are antidilutive.
Basic EPS = [$15,000(NI) − $10,000(preferred dividends)] / 5,000 shares = $5,000 / 5,000 shares = $1/share
Since the EPS after the conversion of the preferred shares is greater than before the conversion the preferred shares are antidilutive and they should not be treated as common in computing diluted EPS. Therefore diluted EPS is the same as basic EPS or $1/share.

clearlycanadian

When considering the impact of warrants on earnings per share, the method to calculate the number of shares added to the denominator is derived using which method?

A) Cost recovery method.

B) Weighted average method.

C) Treasury Stock method.

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The treasury stock method assumes the hypothetical funds received by the company from the exercise of the options are used to purchase shares of the company's common stock in the market at the average market price.

clearlycanadian

When considering convertible preferred stock which of the following components of the earnings per share (EPS) equation needs to be adjusted to calculate diluted earnings per share?

A) The numerator.

B) The denominator.

C) The numerator and denominator.

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The numerator will increase because earnings available to the common shareholder are increased by the reduction in preferred dividends. The denominator increases because the weighted average number of shares increases upon conversion of the preferred stock.