Howard's company earned $320,000 in a year when it had an average of 40,000 ordinary shares...

Howard's company earned $320,000 in a year when it had an average of 40,000 ordinary shares outstanding. The ordinary shares sold at an average market price of $7.5 per share in the year. Also outstanding were 30,000 warrants that could be exercised to buy one ordinary share for $5 for each warrant exercised.

(a) Determine whether the warrant exercised lead to dilutive earnings per share.

(b) Compute the number of treasury shares that can be bought back through proceeds of warrants if exercised. How many related incremental shares that can be issued?

Expert Solution

A) Total proceeds received from exercise of warrants = 30,000 X $ 5 = $ 150,000 , which would have been used to buyback = $150,000 / $ 7.5 = 20,000 ordinary shares. Thus now the denominator for calculating earning per share increased by 10,000 shares ( 30,000 - 20,000).

Revised Earning per share = earnings / [ outstanding ordinary shares + ordinary shares equivalents ( warrants) ]

Revised Earning per share = $ 420,000 / [ 40,000 + 10,000] = 8.40

Previously earnings per share before warrants exercised = $ 420,000 / 40,000 = $ 10.50

So, it is rightly said that warrants exercise lead to dilutive earning per share by ( 10.50 - 8.40) = 2.10

B) Total proceeds from sale of share warrants = 30,000 X $ 5 = $ 150,000

Total number of treasury shares bought back = Total proceeds from sale of share warrants / market price of ordinary shares

Total number of treasury shares bought back = $ 150,000 / $ 7.50 = 20,000 shares.

Net increase in shares = n ( m - e) / m

n = number of shares issuable = 30,000

m = market value of shares = $ 7.50

e = exercise price of warrants = $ 5.00

Number of incremental shares = 30,000 X ( 7.50 - 5.00) / 7.50 = 10,000 shares

ekkarill92 answered 2 years ago

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