In: Accounting
You are an Investor who focuses on IT companies with large future potential in further automation of Global Supply Chain. Last year you bought 5,000 shares in Lama Inc. a company well established in the tech domain. The following data are presented by Lama for calendar 2019
Net income $4,500,000
Common shares outstanding, 1,000,000 shares
10%, cumulative preferred shares, convertible into 120,000 common shares $1,600,000
8% convertible bonds; convertible into 105,000 common shares $7,500,000
360,000 call options exercisable at $25 per share
Additional information
1. The common and preferred shares and the convertible bonds were outstanding from the beginning of the year.
2. In 2019, a $500,000 dividend was declared and paid; however, no dividends were declared in 2016.
3. The average market price of the common shares in 2017 was $30. The stock price was $27 on January 1, 2017, and $35 on December 31, 2017.
4. The convertible bonds were sold at par – no discount or premium .
5. The income tax rate for 2017 is 30%.
Instructions
a) Calculate basic EPS. – 3 Marks
b) Calculate diluted EPS. - 9 Marks
c) What is the importance of reporting diluted EPS? – 3 Marks
1. Basic EPS = Net Income less preferred dividend / Weighted average number common stock outstanding
= $4,500,000 - $160,000 / 1,000,000
= $4.34 per share
2. Diluted EPS
Net Income = Net Income of Basic EPS + Interest on bonds net of tax
= $4,500,000 + [$7,500,000 x 8% (1-0.03)]
= $4,500,000 + $420,000
= $4,920,000
Weighted average number common stock outstanding | 1,000,000 |
Add : Dilutive preferred stock if converted to Common stock | 120,000 |
Add : Dilutive convertible bonds if converted to Common stock | 105,000 |
Add : Dilutive Call options exercised (360,000 shares issued) | 360,000 |
Less : Common stock bought back from proceeds of Option exercised at average market price (360,000 x 25 / 30) |
(300,000) |
Weighted average number common stock outstanding for diluted EPS | 1,285,000 |
Diluted EPS = $4,920,000 / 1,285,000
= $3.83 per share
3. Importance of reporting diluted EPS