Question

The following information relates to the Zipo Company. Compute both basic and diluted EPS for Zipo Company. Hint: solving this problem is very similar to the steps used to solve the “comprehensive example” problem in the Appendix to the chapter. All supporting calculations are to be turned in with the solution. Student groups are encouraged to meet in the classroom during the scheduled class time to work together. Each student is to turn in his/her solution.

1. The Company’s net income for the year was $50,000.

2. The weighted-average number of common shares outstanding is 10,000 shares.

3. The income tax rate is a flat 40%.

4. Series A Options to purchase 1,000 shares of common stock at $8 per share were outstanding all year.

5. Series B Options to purchase 2,000 shares of common stock at $13 per share were outstanding all year.

6. The average market price of common stock during the year was $10.

7. The Company had two hundred 7% convertible bonds outstanding the entire year. Each $1,000 bond converts into 40 common shares. The bonds had been issued at par and no bonds were converted during the year.

8. The Company had 1,000 shares of $100 par value, 4% convertible cumulative preferred stock issued and outstanding the entire year. Each preferred share is convertible into 1.25 shares of common stock. The preferred stock was issued at par value and no shares were converted during the year.

9. The Company had 1,000 shares of $100 par value, 6% non-cumulative, nonconvertible preferred stock issued and outstanding the entire year. The preferred stock was issued at par value.

10. All required preferred dividends were declared and paid during the year as well as a $2 per share dividend to the common stock.

Answer 1

Option 1 Assumed net income of $50,000 is after tax

Option 2 Assumed net income of $50,000 is before tax

1. Compute the weighted average number of common shares Sosa will use to compute basic earnings per share 1-Jan-18 Weighted Average no of shares 10,000 The second step is average out the number of month the shares were outstanding: # of Months 1-Jan-18 Weighted Average no of shares 10,000 12 120,000 120,000 10,000 Sum 12 Weighted Average no of shares 2. Compute 2018 basic earnings per share Basic EPS Net Income Tax Net Income after tax Preference Dividend ( 100000*4% Earnings available for Equity Holder Weighted Average no of shares EPS $50,000 $20,000 $30,000 4,000 $26,000 10,000 2.60

3. Identify which of the potentially dilutive securities (preferred stock, bonds, op are dilutive Increase in earnings available to Equity holders on conversion of potential equity shares Increase in no. earnings per Increase in of Equity Earnin Shares shares ons incremental shares (for Options) I(Market price Option price)/Market price] x Number of tions Market Price $10 $8 1,000 200 on price Number of options incremental shares $10 $13 2,000 Market Price tion price Number of options incremental shares 0 0 if the exercise price of an option or warrant is greater than the market price, the conversion would be antidilutive 4% preferred stock Preferred Stock Preference Dividend (100000.4% incremental shares (1000 x 1,25 Preferred Dividend savin 7% convertible bonds incremental shares (200 x 40 Interest savings @7% Tax @40% Interest savings (net of tax) 4,000 1,250 1,250 200,000 8,000 4,000 3.20 14,000 5,600 8,400 8,000 1.05 It may be noted from above that options are most dilutive as their earnings per incremental shares is nil. Hence for computation of diluted EPS, option will be considered first. Bonds being second most dilutive will be considered next and thereafter preferred will be considered. 4. Compute diluted earnin share Computation of Diluted Earning per share Net profit No of equity attributable Net profit attributable shares $26,000 r share 10,000 As reported tions 2.60 0 200 10,200 $ 8,000 $26,000 8,400 34,400 4,000 38,400 2.55 Dilutive 7% convertible bonds 18,200 $ 1.89 Dilutive Preferred Stock 1,250 19,450 1.97 anti Dilutive Hence Dilluted Earning per share is $1.89