Question

On December 31, 2020, Dow Steel Corporation had 640,000 shares of common stock and 304,000 shares of 8%, noncumulative, nonconvertible preferred stock issued and outstanding. Dow issued a 4% common stock dividend on May 15 and paid cash dividends of $440,000 and $73,000 to common and preferred shareholders, respectively, on December 15, 2021.

On February 28, 2021, Dow sold 57,000 common shares. In keeping with its long-term share repurchase plan, 6,000 shares were retired on July 1. Dow's net income for the year ended December 31, 2021, was $2,300,000. The income tax rate is 25%. Also, as a part of a 2020 agreement for the acquisition of Merrill Cable Company, another 27,000 shares (already adjusted for the stock dividend) are to be issued to former Merrill shareholders on December 31, 2022, if Merrill's 2022 net income is at least $540,000. In 2021, Merrill's net income was $670,000.

As part of an incentive compensation plan, Dow granted incentive stock options to division managers at December 31 of the current and each of the previous two years. Each option permits its holder to buy one share of common stock at an exercise price equal to market value at the date of grant and can be exercised one year from that date. Information concerning the number of options granted and common share prices follows:

	Options Granted
Date Granted	(adjusted for the stock dividend)			Share Price
December 31, 2019		11,000		$	14
December 31, 2020		6,000		$	23
December 31, 2021		9,500		$	22

The market price of the common stock averaged $22 per share during 2021.

On July 12, 2019, Dow issued $800,000 of convertible 8% bonds at face value. Each $1,000 bond is convertible into 35 common shares (adjusted for the stock dividend).

Required:
Compute Dow's basic and diluted earnings per share for the year ended December 31, 2021. (Enter your answers in thousands. Round "Earnings per share" answers to 2 decimal places. Do not round intermediate calculations)

Answer 1

Answer:

	Numerator	/	Denominator	=	Earnings per share
Dow's basic	2,227	/	712	=	3.13
Dow's diluted	2,275	/	771	=	2.95

Calculation

The options issued in 2021 do not affect the EPS calculation of 2021, because the exercise price is 22 which is same as market price. Hence these options are neither dilutive nor anti dilutive.

Options issued in 2020 not considered when calculating EPS because the share price is 23 which is more than the average market price that is 22. As a result, these options are antidilutive.

The options issued in 2019 are exercised for 11,000 shares when calculating 2021 EPS because the exercise price which is 14 , that is less than the average market price of $22. So, the treasury shares are repurchased at the average price for diluted EPS. It is taken into calculation for Exercise of options in the weighted average shares for Diluted EPS.

Basic EPS:

Net income = 2,300,000

Preferred Shareholder divided = 73,000

Basic EPS numerator = Net income - Preferred Shareholder divided

= (2,300,000 - 73,000 ) = 2,227,000

Shares at Jan. 1 = 640,000

New Shares = 57,000

Adjustment as it was bought on February 28, = 57000 * 10/12 = 47,500

Shares retired = 6,000

Adjustment as it was reired on july 1, = 6000*6/12 = 3,000

Basic EPS denominator = (Shares at January 1 * Stock dividend adjustment) + (New Shares * Stock dividend adjustment) - Shares retired =  

=((640,000*(1+0.04))+((57,000*(10/12))*(1+0.04))-((6,000*(6/12))

= ((640,000*(1+0.04))+(47,500 *(1+0.04)) - 3,000

= 712,000

Basic EPS = 2,227,000 / 712,000 = 3.13

Diluted EPS:

Net income = 2,300,000

Preferred Shareholder divided = 73,000

After Tax Interest Saving = 800,000 * 8% = 64,000- (64,000* 25%) = 48,000

Diluted EPS numerator = Net income - Preferred Shareholder divided + After Tax Interest Saving

= (2,300,000 - 73,000) +((800,000 * 8% ) - ((800,000 * 8%)*25%)))

= (2,300,000 - 73,000) + 48,000

= 2,275,000

Shares at Jan. 1 = 640,000

New Shares = 57,000

Adjustment as it was bought on February 28, = 57,000 * 10/12 = 47,500

Shares retired = 6,000

Adjustment as it was reired on july 1, = 6000*6/12 = 3,000

Treasury shares are assumed repurchased at the average price for diluted EPS:

The options issued in 2019 are considered exercised for = 11000 Shares

Exercise Price = 14

So, 11000 shares * 14(exercise price) = 154,000

Average market price = 22

So, 154,000 / 22= 7,000 shares

Exercise of options = 11,000 Shares - 7,000 shares = 4,000

Contingent shares = 11,000 (shares already adjusted for the stock dividend)

Conversion of Bonds = (800,000  / 1000 ) * 35= 28,000

Diluted EPS denominator = (Shares at Jan * Stock Dividend Adjustment) + (New Shares * Stock Dividend Adjustment) - Shares retired + Exercise of Options + Contingent share + Conversion of Bonds =

= ((640,000 *(1+0.04))+((57,000 *(10/12)) * (1+0.04)) - ((6,000 *(6/12))) + (11,000 - 7,000 )+ 11,000 +((800,000/1000 )*35))

= ((640,000 *(1+0.04))+( 47,500* (1+0.04)) - 3000 + 4,000 + 27,000 + 48,000 =

= 771,000

Diluted EPS = 2,275,000/ 771,000= 2.95