Question

Throughout 2019, H had 15,000,000 shares of common stock issued and outstanding and 100,000 shares of 5%, $100 par value cumulative preferred stock issued and outstanding. H's net income for 2019 was $7,700,000. During 2019 H neither declared nor paid any kind of dividend. H's income tax rate is 25%.

• During the entire year ending 12-31-19, H had 750,000 outstanding and exercisable employee stock options that were granted to employees during 2016. Each option has an exercise price of $40 per share of H common stock. During 2019, the average market price of H's common stock was $60 per share.
• As of 12-31-19, H had $3,000,000 of 6%, 15-year convertible bonds. H issued the bonds at par during 2005. The bonds can be converted into 40,000 shares of H's common stock.
• As of 12-31-19, H had $40,000,000 of 8%, 40-year convertible bonds. H issued the bonds at par during 1995. The bonds can be converted into 300,000 shares of H's common stock.

What will H report as basic EPS for the year ended 12-31-19?

What will H report as diluted EPS for the year ended 12-31-19?  

Answer 1

Net Income = $7,700,000

Shares outstanding = 15,000,000

Preferred Dividend = $0 (H has neither declared nor paid any kind of dividend in 2019)

Basic EPS = Net Income - Preferred Dividend / Shares Outstanding

Basic EPS = ($7,700,000 - $0) / 15,000,000  

Basic EPS = $0.5133 $0.51

Convertible bonds Interest of 15-year, 6%, $3,000,000

Convertible bonds Interest = Face value * Coupon rate

Convertible bonds Interest = $3,000,000 * 6%

Convertible bonds Interest = $180,000

No of shares created on conversion of 15-year, 6%, $3,000,000 Convertible bonds = 40,000

Convertible bonds Interest of 40-year, 8%, $40,000,000

Convertible bonds Interest = Face value * Coupon rate

Convertible bonds Interest = $40,000,000 * 8%

Convertible bonds Interest = $3,200,000

No of shares created on conversion of 40-year, 8%, $40,000,000 Convertible bonds = 300,000

No of shares created if stock options are exercised = 750,000

Cash inflow if options are exercised = Exercise price * No of shares created if stock options are exercised

Cash inflow if options are exercised = $40 * 750,000

Cash inflow if options are exercised = $30,000,000

No of shares that can be purchased with these funds = Cash inflow if options are exercised / Current share price

No of shares that can be purchased with these funds = $30,000,000 / 60

No of shares that can be purchased with these funds = 500,000

Net increase in common shares outstanding from exercise of the stock options = (No of shares created if stock options are exercised - No of shares that can be purchased with these funds)

Net increase in common shares outstanding from exercise of the stock options = 750,000 - 500,000

Net increase in common shares outstanding from exercise of the stock options = 250,000

Dilutive EPS = (Net Income - Preferred Dividend + 40-year, 8%, $40,000,000 Convertible bond interest * (1 - tax rate) + 15-year, 6%, $3,000,000 Convertible bond interest * (1 - tax rate)) / (Shares outstanding + No of shares created on conversion of 40-year, 8%, $40,000,000 Convertible bonds + No of shares created on conversion of 15-year, 6%, $3,000,000 Convertible bonds + Net increase in common shares outstanding from exercise of the stock options)

Dilutive EPS = ($7,700,000 - $0 + $3,200,000 * (1 - 25%) + $180,000 * (1 - 25%) ) / (15,000,000 + 300,000 + 40,000 + 250,000)

Dilutive EPS = $0.6565 $0.66