Question

Mr. Ahmed is a fresh accounting graduate. He has been employed by a big industrial company in the country; (Prime Company). The company is specialized in manufacturing primary care equipment for various entities in the country. The company is focused on the local market with about 90% of the sales are made for local entities. The company is listed on the local securities market.

It is the end of 2019 and Mr. Ahmed was asked to calculate the basic and diluted earnings per share figures for the company. Given the importance of the earnings per share figure to the company and the market, as a performance measure, Mr. Ahmed was keen to do the job properly. Therefore, he started gathering relevant information to be able to calculate these two figures. The following is a summary of the information he gathered:

1. There were 2,500,000 shares outstanding at the beginning of 2019.

2. The company has preference share capital of $6,000,000 at the beginning of 2019. These were

9%, cumulative, convertible preference shares with $2 par value per share. The preference shares were issued at par. Each preference share is convertible into two ordinary shares. The conversion rate of preference shares must be adjusted for any share dividend or share split occurring during the year. On 1 May 2019, 250,000 preference shares have been converted into ordinary shares. Another 250,000 shares have been repurchased at cost on the same date. The remaining shares were outstanding until year-end. The preference dividend is paid every 4 months.

3. The company has two convertible debt instruments outstanding at the end of 2019 as follows:

a. Convertible bond class (A): This is a $1,000,000 face value, 6%, 10-year bond that was issued on 1 January 2016. These bonds pay interest semi-annually and are convertible into 500,000 ordinary shares. The total issue price of the bond was $1,100,000. On 1

October 2019, the holders of the bonds converted 30% of them into ordinary shares.

b. Convertible bond class (B): This is a $5,000,000 face value, 10%, 5-year bond that was issued on 1 October 2019. Each $10 bond is convertibles into two ordinary shares. The

bonds pay interest annually. The total issue price of the bond was $6,000,000.

4. On 1 March 2019, the company declared and distributed a 20% share dividend to outstanding

shareholders.

5. On 1 April 2019, The Company executed a 3:1 share split on outstanding shares.

6. On 1 January 2019, the company granted its executives 120,000 options with an exercise price of

$25 per share. The options are valid for two years and are considered for compensation purpose. The service period was estimated to be two years. The options were valued at $1,800,000. The following table summarizes the exercise/expiry of options during 2019:

Date Percentage of options exercised Average market price per share ($)

1 July 20% 30

The average market price of ordinary shares on 31 December 2019 was $20 per share.

7. Net income for 2019 was $16,000,000.

8. The effective market rate was 8% and the tax rate was 25%.

4

Questions:

1. The earnings per share figure is one of the most important accounting-based figures to be reported, especially for publicly listed companies such as Prime Company. Explain why.

2. Do you believe that the earnings per share is also important for private/non-public companies? Explain your answer

3. Using the information in PART (A) above, calculate the following:

a. The basic earnings per share for the year 2019.

b. The diluted earnings per share for the year 2019

Answer 1

ANSWER 1.

EPS is an important factor used in valuing a company because it breaks down a firm's profits on a per share basis. It is a term that is of much importance to investors and people who trade in the stock market. The higher the earnings per share of a company, the better is its profitability.EPS indicates how much money a company makes for each share of its stock and is a widely used metric for corporate profits. A higher EPS indicates more value because investors will pay more for a company with higher profits.EPS is the portion of a company’s profit that is allocated to every individual share of the stock. It is a term that is of much importance to investors and people who trade in the stock market. The higher the earnings per share of a company, the better is its profitability. While calculating the EPS, it is advisable to use the weighted ratio, as the number of shares outstanding can change over time.

ANSWER 2.

Yes, i do believe.Though EPS is mostly used in public companies, it can also be used for private investments. Using the same method of valuation in calculating EPS for private holdings, investors have a better idea of the return on investment as well as the profitability levels of the company.

ANSWER 3.

Basic eps = Net income- preferred dividend / WANSO

=1600000-540000(6000000*9%) / 2500000

=6.184

Diluted EPS Formula = Net Income(Before Preferred Dividends)+After Tax Cost of Interest / (Common Shares Outstanding +Additional Shares Against Exercise of Convertible Securities)

=(16000000+275000) / (2500000+250000+330000)

=16275000/3080000

=5.28