Question

Problem 19-17 EPS; options; convertible preferred; additional shares [LO19-4, 19-5, 19-6, 19-7, 19-8, 19-9]

On January 1, 2018, Tonge Industries had outstanding 460,000 common shares ($1 par) that originally sold for $25 per share, and 5,000 shares of 10% cumulative preferred stock ($100 par), convertible into 50,000 common shares.

On October 1, 2018, Tonge sold and issued an additional 12,000 shares of common stock at $35. At December 31, 2018, there were 21,000 incentive stock options outstanding, issued in 2017, and exercisable after one year for 21,000 shares of common stock at an exercise price of $32. The market price of the common stock at year-end was $50. During the year, the price of the common shares had averaged $42.

Net income was $600,000. The tax rate for the year was 40%.

Required:
Compute basic and diluted EPS for the year ended December 31, 2018. (Enter your answers in thousands.)
  

Answer 1

1.Numerator (Basic EPS) :

Net Income- $600,000

Preferred Dividend- $50,000 [(10% ×$100) × 5000]. Because, the preferred stock is cumulative, dividends are included whether or not paid.

Denominator (Baisc EPS) :

Weighted average # shares common stock outstanding

1/1 - 12/31. [460000 × (12/12)] = 460000

10/1 - 12/31. [12000 × (3/12)] = 3000

   463,000

Basic EPS = ($600,000 - $50,000) ÷ 463,000 = $1.19

2.Diluted EPS :

a. They are dilutive because exercise price is $32 less than average market price $50.

b. They exercise at the later date if issue is 2017 and beginning at (1/1/2018) therefore, assume exercise (1/1/2018)

c. Proceed received on exercise (21000 × $32) =$672,000

d. Shares purchased ($672,000 ÷ $42) = $16000

e. Nat increases in shares outstanding = 5000 (21000 - 16000)

f. EPS with the inclusion:

($600000 - $50000) ÷ (463,000 + 5000) = $1.18 (i.e. used for dilute convertible preferred stock)

3. Convertible preferred stock:

a. Assume conversation on 1/1/2018

b. Dividend not paid = $50000

c. Additional shares on conversation = 50000

d. Conversation ratio = $50000 : 50000 = 1

e. Dilutive because $1 is less than $1.18

Therefore,

1. Basic EPS = $1.19

2. Dilutive EPS = ( 600000 - $50000 + 50000) ÷ (463000 + 5000 + 50000 ) = $1.16