Question

Problem 19-13 (Algo) EPS; nonconvertible preferred stock; treasury shares; shares sold; stock dividend; options; convertible bonds; contingently issuable shares [LO19-4, 19-5, 19-6, 19-7, 19-8, 19-9, 19-10, 19-11]

On December 31, 2020, Dow Steel Corporation had 770,000 shares of common stock and 317,000 shares of 9%, noncumulative, nonconvertible preferred stock issued and outstanding. Dow issued a 5% common stock dividend on May 15 and paid cash dividends of $570,000 and $86,000 to common and preferred shareholders, respectively, on December 15, 2021.

On February 28, 2021, Dow sold 68,000 common shares. In keeping with its long-term share repurchase plan, 4,000 shares were retired on July 1. Dow's net income for the year ended December 31, 2021, was $2,950,000. The income tax rate is 25%. Also, as a part of a 2020 agreement for the acquisition of Merrill Cable Company, another 35,000 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 $670,000. In 2021, Merrill's net income was $800,000.

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		24,000		$	40
December 31, 2020		19,000		$	49
December 31, 2021		22,500		$	48

The market price of the common stock averaged $48 per share during 2021.

On July 12, 2019, Dow issued $900,000 of convertible 8% bonds at face value. Each $1,000 bond is convertible into 40 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

Dow’s Basic Earnings per share:

Basic EPS = Net Income preferred dividend / Weighted avg. common stock

Net Income preferred dividend = 2,950,000 – 86,000 = 2,864,000

Weighted Avg. common stock
770,000*12/12*1.05	808,500
68,000*10/12*1.05	59,500
4,000*6/12	-2,000
Total	866,000

Basic EPS = 2,864,000 / 866,000 = $3.31

Dow’s Diluted Earnings per share:

The first step is to find out the potential stock options.

Options are dilutive only when the market price is more than exercise price.

So, Dec 31,2019 is the only dilutive options here Which has exercise price of $40 < $48 (Market price).

If exercised, 24000*40 = 960,000

If purchased from market (960,000/48) = 20,000

No. of Dilutives are = 24,000 - 20,000 = 4,000 (potential stocks)

Each $1000 bonds can be converted to 40 common shares

Convertible bonds = 900,000 / 1000*40 = 36,000 (Potential stocks)

After tax interest = 900,000*8%*(1-0.25) = 54,000

Total Stock = 866,000 + 4,000 + 36,000 = 906,000

Net income-preferred dividend after tax interest = 2,864,000 + 54,000 = 2,918,000

Diluted EPS = Net income-preferred dividend after tax interest/ Total Stock

                        = 2,918,000 / 906,000 = $3.22