Question

On December 31, 2020, Dow Steel Corporation had 650,000 shares of common stock and 305,000 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 $450,000 and $74,000 to common and preferred shareholders, respectively, on December 15, 2021.

On February 28, 2021, Dow sold 64,000 common shares. In keeping with its long-term share repurchase plan, 7,000 shares were retired on July 1. Dow's net income for the year ended December 31, 2021, was $2,350,000. The income tax rate is 25%. Also, as a part of a 2020 agreement for the acquisition of Merrill Cable Company, another 26,000 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 $550,000. In 2021, Merrill's net income was $680,000.

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 12,000 $ 16

December 31, 2020 7,000 $ 25

December 31, 2021 10,500 $ 24

The market price of the common stock averaged $24 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 30 common shares (adjusted for the stock dividend).

Required: Compute Dow's basic and diluted earnings per share for the year ended December 31, 2021.

*****answer to Dow's Basic is: ($2,276 (numerator) / 735 (denominator)= 3.10 EPS)

Answer 1

Requirement:- Compute Dow's basic and diluted earnings per share for the year ended December 31, 2021

	Numerator	/	Denominator	=	Earning Per Share
Dow's Basic	2,276,000	/	735,000	=	$3.10
Dow's Diluted	2,330,000	/	792,000	=	$ 2.94

Working Note:-

Calculation for the Basic Earning per share.

Net income = $2,350,000

Preferred dividend = $74,000

Outstanding common shares = (Shares at January 1 * Stock dividend adjustment) + (New Shares * Stock dividend adjustment) - Shares retired

Outstanding Common shares = {(650,000 * (1+0.05)} +{(64,000 * 10/12) * (1+0.05) - (7,000 * 6/12)

Outstanding Common shares = (682,500) + {(53,333.33) * (1+0.05)} - (3,500)

Outstanding Common shares = (682,500) + (56,000)  - (3,500)

Outstanding Common shares = 735,000

Basic Earning per share Formula = (Net income - Preferred dividend) / Outstanding Common Shares

Basic Earning per share = (2,350,000 - 74,000) / 735,000

Basic Earning per share = $3.10

Diluted EPS:
Net income = 2,350,000
Preferred Shareholder divided = 74,000
After Tax Interest Saving = 900,000 * 8% = 72,000- (72,000* 25%) = 54,000
Diluted EPS numerator = Net income - Preferred Shareholder divided + After Tax Interest Saving
=	2,350,000-74,000+54000
=	2,330,000
For calculation of Diluted EPS denominator
a)Shares at Jan. 1 = 650,000
b) New Shares = 64,000
Adjustment as it was bought on February 28, = 64,000 * 10/12 = 53,333
c) Shares retired = 7,000
Adjustment as it was reired on july 1, = 7000*6/12 = 3,500
Treasury shares are assumed repurchased at the average price for diluted EPS:
d) The options issued in 2019 are considered exercised for = 12000 Shares
Exercise Price = 16
So, 12000 shares * 16(exercise price) = 192,000
Average market price = 24
So, 192,000 / 24= 8,000 shares
Exercise of options = 12,000 Shares - 8,000 shares = 4,000
e)Contingent shares = 26,000 (shares already adjusted for the stock dividend)
f) Conversion of Bonds = (900,000  / 1000 ) * 30= 27,000
Diluted EPS denominator = (Shares at Jan * Stock Dividend Adjustment) + (New Shares * Stock Dividend Adjustment) - Shares retired + Exercise of Options + Contingent share + Conversion of Bonds
=	((650,000 *(1+0.05))+ (53,333*(1+0.05)-3500+ 4000+26000+ 27000)
=	792,000
Diluted EPS = 2,330,000/ 792,000= 2.94

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