Question

Problem Facts Information related to the Sosa Company for the year 2020: Common Stock As of the end of 2020, Sosa had 240,000 shares of common stock outstanding. The shares are due to the following common stock transactions:  January 1, 2020 – 100,000 shares of common stock outstanding  April 1, 2020 – issued an additional 50,000 shares for cash  July 1, 2020 - issued a 2 for 1 stock split  September 1, 2020 – purchased 60,000 shares for treasury stock Preferred Stock As of the end of 2020, Sosa had 30,000 shares of 6%, $10 par value, cumulative, convertible preferred stock outstanding. The stock had been outstanding all year and the conversion ratio was each share of preferred stock is convertible into 3 shares of common stock. Bonds Payable As of the end of 2020, Sosa had $800,000, 7% bonds payable outstanding. The bonds had been outstanding for the entire year and each $1,000 bond was convertible into 10 shares of common stock. Options Sosa also had 10,000 common stock options outstanding all year. Each option allowed the holder to purchase 1 share of Sosa’s common stock for $45. During 2020, the average market price of Sosa’s common stock was $48 per share. Additional Information Sosa’s 2020 net income was $580,000, and the company’s income tax rate was 34%. REQUIRED 1. Compute the weighted average number of common shares Sosa will use to compute basic earnings per share. (5 points) 2. Compute 2020 basic earnings per share (3 points) 3. Identify which of the potentially dilutive securities (preferred stock, bonds, options) are dilutive (support must be shown to receive credit for this question) (8 points) 4. Compute diluted earnings per share (4 points)

Basic EPS = $2.20

Diluted EPS = $1.68

Answer 1

1. Calculation of Weighted Average Number of Common Shares -

Event	Number of Shares	Outstanding Period in Months	Total Number of Months	Weighted Average Number of Shares
Opening Balance of Number of Shares	100000	12	12	100000
Add: Additional Capital Issued on 1 Apr	50000	9	12	37500
less: Buy Back of Shares on 1 Sep	60000	-4	12	-20000
Total				117500

Bonus Shares issued = 150000 x 2 = 300000 , these will be added to weighted average number of shares without any time apportionment as per relevant IFRS

So, Weighted Average Number of Shares to calculate BEPS will be 417500

2. Net Income of Sosa in 2020 = $ 580000

Less : Tax @ 34% = $ 197200

Net Income after Tax = $ 382800 - Pref stock dividend of $ 18000 = $ 364800

Basic EPS = Net Income/Weighted Avg Numnber of Shares

= $ 364800/417500 = $ 0.87 per share

3. Out of the 3 potentially dilutive securities, only that case will be dilutive if it will reduce the basic eps if it is converted into equity stock-

Preferred stock- total dividend = 30000 x 10 x 6% = $ 18000

Number of Equity shares receivable if preferred stock converted - 30000 x 3 = 90000

Above dividend will not be paid after conversion,

Now, $ 18000/90000 = 0.20 which is less than basic EPS, therefore preferred stock is dilutive

Bonds - Interest payable on bonds (net of tax) = $ 800000 x 7% x 66% = $ 36960

Number of Equity shares receivable if Bonds converted = $ 800000/1000 x 10 = 8000 shares

Now, $ 36960/8000 = 4.62 which is more than basic EPS, therefore preferred stock is not dilutive

Options - Options can be excercised at $ 45 , where as avg. market price is $ 48, therefore option is in the money and is dilutive

4. Diluted EPS can be calculated below -

Net Income wihtout Pref stock div. /(weighted Avg no. of shares + Pref stock converted shares + stock options)

= ($ 364800 + $ 18000)/ (417500 + 90000 + 10000) = $ 0.74 per share