Question

Part a

The following information pertains to Torque Corp.’s outstanding stock for 2021:
Common stock, $1 par value
Shares outstanding, 1/1/2021 60,000
2-for-1 stock split, 4/1/2021
Shares issued, 7/1/2021 30,000
   
Preferred stock, $10 par value, 6% cumulative
Shares outstanding, 12/31/2021 12,000
Torque reported net income for 2021 of $500,000.
Required
Compute Torque Corp.’s basic earnings per share for 2021.

Part b

Farewell Inc. had 500,000 shares of common stock outstanding throughout 2021.
Farewell's net income for the year ended December 31, 2021, was $2.5 million. The income tax rate is 25%.
Farewell granted 10,000 stock options to its executives on December 15, 2020. Each option gives its holder the right
to buy 20 shares of common stock at an exercise price of $29 per share. The options vest after one year. The market
price of Farewell’s common stock averaged $30 per share during 2021.
Required
Compute Farewell’s basic and diluted earnings per share for 2021.

Answer 1

Earnings per Share (EPS) measures the profit of Company per share basis. It is calculated by dividing the company’s earnings attributable to equity share holders' with its total number of outstanding equity shares. It is a tool that market participants use frequently to gauge the profitability of a company before buying its shares.

EPS= Earnings attributable to Equity Share Holders' / Weighted average of Outstanding Equity Shares

Diluted Earnings per Share (Diluted EPS)  is a metric used in fundamental analysis to gauge a company's quality of earnings per share assuming all convertible securities have been exercised. Convertible securities include all outstanding convertible preferred shares, convertible debt, equity options (mainly employer-based options), and warrants.

Diluted EPS= Earnings attributable to Equity Share Holders' after effect of Potential Equity Shares / Weighted Average of outstanding shares after effect of Potential Equity Shares

PART A

Net Income of Torque (after Tax)= $ 5,00,000 [Since the Tax Rate is not given it is assumed as After Tax]

Dividend paid on Preffered Stock = $ 7,200 (12,000*10*6%)

Income Attributable to Equity Share Holders'= $4,92,800 (5,00,000-7,200)

Calculation of Weighted Average Outstanding Equity Shares

Shares outstanding during the year= (60,000 * 12/12) + (30,000*12/12) + (30,000 * 8/12)= 1,10,000

Basic EPS= 4,92,800/1,10,000= $4.48

PART B

Net Income= $2.5 million

Tax Rate= 25%

Tax Liability= $0.625 million

Income Attributable to Equity Share Holders'= $ 1.875 million

Basic EPS= $18,75,000/50,000= $35.50

Calculation of Potential Equity Shares in Stock Options

PES= [Number of options granted] - [(Options*Exercise Price) / Average fair value of shares during the year]

PES= [2,00,000 ]- [(2,00,000*29)/30] = 6,667 shares

Diluted EPS = Net income attributable to Equity Share Holders' / (Weighted Average outstanding shares + PES in options)

Diluted EPS = $1.875 million/ 56,667 = $ 33.09

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