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    Diluted EPS Solution

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    taliaferomwas
    The document provides an example solution to calculating diluted EPS using the if-converted and treasury stock methods. It shows the calculations for adjusting net income and weighted average shares for convertible bonds and stock options. The net income is adjusted by adding back interest expenses and the weighted average shares is increased by the potential conversion of bonds and exercise of options.

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    Diluted EPS Solution

    Uploaded by

    taliaferomwas
    30 views2 pages
    The document provides an example solution to calculating diluted EPS using the if-converted and treasury stock methods. It shows the calculations for adjusting net income and weighted average shares for convertible bonds and stock options. The net income is adjusted by adding back interest expenses and the weighted average shares is increased by the potential conversion of bonds and exercise of options.

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    Diluted-EPS-Solution

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    The document provides an example solution to calculating diluted EPS using the if-converted and treasury stock methods. It shows the calculations for adjusting net income and weighted average shares for convertible bonds and stock options. The net income is adjusted by adding back interest expenses and the weighted average shares is increased by the potential conversion of bonds and exercise of options.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    30 views2 pages

    Diluted EPS Solution

    Uploaded by

    taliaferomwas
    The document provides an example solution to calculating diluted EPS using the if-converted and treasury stock methods. It shows the calculations for adjusting net income and weighted average shares for convertible bonds and stock options. The net income is adjusted by adding back interest expenses and the weighted average shares is increased by the potential conversion of bonds and exercise of options.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 2

    In-class Exercise (Diluted EPS) Solution

    Part 1: Diluted EPS, if-converted method


    Thompson Corporation has net income of $210,000 for the year and a weighted-average
    number of common shares outstanding during the period of 100,000 shares. The basic earnings
    per share is thus $2.10 ($210,000/100,000). The company has two convertible debenture bond
    issues outstanding. One is a 6 percent issue sold at 100 (total $1,000,000) in a prior year and
    convertible into 20,000 common shares. The other is a 10 percent issue sold at 100 (total
    $1,000,000) on April 1 of the current year and convertible into 32,000 shares. The tax rate is
    40%.
    Required:
    Calculate the Diluted Earnings Per Share using the if-converted method.

    Step 1 (description)
    To determine the numerator for diluted EPS, fist add back the interest on the if-converted
    securities, less the related tax effect.1 Because the if-converted method assumes conversion as of
    the beginning of the year, the firm assumes that it pays on interest on the convertibles during the
    year. The interest on the 6% convertibles is thus $60,000 ($1,000,000 * 6%). The increased tax
    expense is $24,000 ($60,000 * 40%). The interest added back, net of taxes, is therefore $36,000
    ($60,000 - $24,000, or simply $60,000 * [1 – 0.40]).
    Because the firm issued the 10% convertibles after the beginning of the year, it needs to weight
    the shares. In other words, it considers these shares to have been outstanding from April 1 to the
    end of the year. As a result, the interest adjustment to the numerator for these bonds reflects the
    interest for only nine months. Thus the interest added back on the 10% convertible is $45,000
    ($1,000,000 * 10% * (9/12) * [1 – 0.40]).

    Step 1 (computations)

    Net income for the year 210,000


    Add: adjustment for interest (net of tax)
    6% debentures ($60,000 * [1 - .40]) 36,000
    10% debentures ($100,000 * (9/12) * [1 - .40]) 45,000
    Adjusted net income 291,000

    1
    We add back the interest, because if we convert the debt to equity we don’t need to pay interest anymore.
    Step 2 (description)
    We now calculate the weighted-average number of shares outstanding.

    Step 2 (computations)

    Weighted-average number of shares outstanding 100,000


    Add: shares assumed to be issued:
    6% debentures (as of beginning of the year) 20,000
    10% debentures (as of date of issue, April 1; 9/12 *
    32,000) 24,000
    144,000

    Step 3: Computation of Diluted EPS


    291,000
    = $2.02
    144,000

    Part 2: Diluted EPS, Treasury Stock Method


    Use the information below to calculate diluted EPS using the treasury stock method:
    Net income: $220,000
    Weighted-average shares outstanding: 100,000
    Basic EPS: $2.20
    The average number of stock options outstanding throughout the year was 5,000.
    The stock options give holders the right to purchase shares of stock at a price of $20 per share.
    The average stock price of the firm during the year was $28 per share.

    Average number of shares related to options outstanding 5,000


    Option price per share 20
    Proceeds upon exercise of options (5,000 * $20) 100,000
    Average market price of common stock 28
    Treasury shares that could be repurchased with the proceeds ($100,000 / $28) 3,571

    Excess of shares under option over the treasury shares that could be repurchased (5,000 - 3,571) 1,429
    (potential common incremental shares)

    Net Income 220,000


    Weighted-average of common shares outstanding 100,000
    Diluted EPS (220,000 / [100,000 + 1,429]) 2.17

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