Question

Yellowjacket Corp. has a net income for 2019 of 20. Yellowjacket has 60 shares of common stock issued, 10 of which are treasury shares, and 140 authorized shares.

1. Compute basic EPS assuming Yellowjacket has not issued stock and has not altered its treasury stock during the fiscal year.

2. Now assume that Yellowjacket had a 2-for-1 stock split on July 1^st, increasing their issued shares from 60 to 120 (treasury shares from 10 to 20). Yellowjacket’s fiscal year-end is December 31^st. Re-compute the basic EPS for Yellowjacket.

3. Now disregard the stock split in part b (i.e., shares issued and outstanding are as indicated in part a). Assume Yellowjacket had 10 convertible bonds with an overall face value of $5,000 since the beginning of the fiscal year – the bonds were issued at par with a 3% coupon rate. Yellowjacket has an effective tax rate of 35% and each bond is converted to 2 shares of stock. Compute Yellowjacket’s diluted EPS.

Answer 1

1. Basic EPS=Net income/No of shares outstanding

No of shares outstanding = 60-10=50(Treasury stock is excluded while calculating no. of shares outstanding)

EPS=20/50=0.40

2. In case of stock split, it is considered as if it has occurred during the beginning of the year. Hence, there is no need to adjust no. of shares by issuing weightage of time.

EPS=20/100=0.20

Or simply we can even calculate by dividing the EPS before stock split by 2.

3.Diluted EPS= Diluted earnings/(No. of shares outstanding + Potential Equity shares)

Potential equity shares= 10 bonds*2 shares per bond = 20 Shares

Diluted earnings refer to those earnings which the company would have earned if all potential equity shares like convertible bonds, convertible preference shares, etc are converted to equity shares.

In the current scenario PAT=20

Tax rate = 35%

PBT=20*100/65

=30.77

Interest Amount=5000*3%=150

PBIT=30.77+150=180.77

If all the convertible bonds would have been converted into equity shares then there will be no interest expense.

Hence, PBIT=PBT

PAT=180.77-35%

=117.50

Diluted earnings=117.50

Dilutes EPS= 117.50/(50+20)

=$1.679(Rounded off)