Question

On December 31, 2017, Berclair Inc. had 280 million shares of common stock and 3 million shares of 9%, $100 par value cumulative preferred stock issued and outstanding. On March 1, 2018, Berclair purchased 24 million shares of its common stock as treasury stock. Berclair issued a 5% common stock dividend on July 1, 2018. Four million treasury shares were sold on October 1. Net income for the year ended December 31, 2018, was $250 million. The income tax rate is 40%.

Also outstanding at December 31 were incentive stock options granted to key executives on September 13, 2013. The options are exercisable as of September 13, 2017, for 30 million common shares at an exercise price of $56 per share. During 2018, the market price of the common shares averaged $70 per share.

In 2014, $62.5 million of 8% bonds, convertible into 6 million common shares, were issued at face value.

Required:

Compute Berclair’s basic and diluted earnings per share for the year ended December 31, 2018

Answer 1

Calculation of Basic Earnings Per Share of Berclair Inc. for the year ended December 31, 2018

Basic earnings per share = Net Income - Preferred Dividends / Average Number of Common Shares Outstanding

Net Income = $250,000,000 ($250 million)

Preferred Dividends = No: of Preferred shares * Par value *% of cumulative preferred   dividend)

                                             = 3,000,000* $100*9%

                                             = $ 27,000,000

Average Number of Common Shares Outstanding = ?

So, we should calculate the Average Number of Common Shares Outstanding from the given information:

i. On December 31, 2017, Berclair Inc. had 280 million shares of common stock

ii.On March 1, 2018, Berclair purchased 24 million shares of its common stock as treasury stock. Berclair issued a 5% common stock dividend on July 1, 2018.

iii.Four million treasury shares were sold on October 1.

Periods	Shares Outstanding(a)	5% Dividend issued on July 1, 2016 (b)	Shares Outstanding(c)=(a+b)	Shares Outstanding of end of period after adjustments	Portion of Year	Weighted shares
Purchased:
Dec 31, 2017 - Feb 28,2018 (See Info:No:i)	2,80,00,000	1,40,00,000	29,40,00,000	29,40,00,000	For 2 months	4,90,00,000
Mar 1,2018 - Sep 30,2018 (See Info:No.ii)	2,40,00,000	12,00,000	2,52,00,000	268,800,000 (294000000-25200000)	For 7 months	15,68,00,000
Sold:
Oct 1,2018 - Dec 31,2018 (See Info:No.iii)	40,00,000	Nil	Nil	272,800,000 (268,800,000+40,00000)	For 3 months	6,82,00,000
Weighted average number of outstanding shares						274,000,000(274 million)

Average Number of Common Shares Outstanding = 274,000,000 shares

Therefore,

Basic earnings per share = Net Income - Preferred Dividends / Average Number of Common Shares Outstanding

                                 = $ 250,000,000 - $ 27,000,000 / 274,000,000 shares

                                 = $223,000,000 / 274,000,000 shares

Basic earnings per share = 0.814

Calculation of Diluted Earnings Per Share of Berclair Inc. for the year ended December 31, 2018

Diluted earnings per share = Net Income - Preferred Dividends / Average Number of Common Shares Outstanding including Common Stock Equivalents

Net Income = $250,000,000 ($250 million)

Preferred Dividends = No: of Preferred shares * Par value *% of cumulative preferred   dividend)

                                             = 3,000,000* $100*9%

                                             = $ 27,000,000

Common Stock Equivalents = ?

So, we should calculate the Common Stock Equivalents from the given information:

i.The options are exercisable as of September 13, 2017, for 30 million common shares at an exercise price of $56 per share. During 2018, the market price of the common shares averaged $70 per share. We use the Treasury Stock method to calculate the dilution from these incentive stock options:

Number of options outstanding 30,000,000

Average exercise price: $56 per share

Treasury Stock Method:

Additional Shares Issued if Options Are Exercised = $70 - $56 / $56 * 30,000,000 options = 7,500,000 shares

ii. In 2014, $62.5 million of 8% bonds, convertible into 6 million common shares, were issued at face value.

Number of common shares convertible under issuance of 8% bonds = 6,000,000 shares

So, Total Common Stock Equivalents = Additional Shares Issued if Options Are Exercised ₊ Number of common shares convertible under issuance of 8% bonds

                                                                 = 7,500,000 +6,000,000

                                                                 = 13,500,000 shares

                                                                                                                                                                          

Therefore,

Diluted earnings per share = Net Income - Preferred Dividends / Average Number of Common Shares Outstanding including Common Stock Equivalents

                          = $ 250,000,000 - $ 27,000,000 / ( 274,000,000 + 13,500,000) shares

                           = $223,000,000 / 287,500,000 shares

Diluted earnings per share = 0.776