Question

On December 31, 2017, Dow Steel Corporation had 720,000 shares of common stock and 42,000 shares of 8%, noncumulative, nonconvertible preferred stock issued and outstanding. Dow issued a 4% common stock dividend on May 15 and paid cash dividends of $520,000 and $81,000 to common and preferred shareholders, respectively, on December 15, 2018.

On February 28, 2018, Dow sold 66,000 common shares. Also, as a part of a 2017 agreement for the acquisition of Merrill Cable Company, another 19,000 shares (already adjusted for the stock dividend) are to be issued to former Merrill shareholders on December 31, 2019, if Merrill's 2019 net income is at least $620,000. In 2018, Merrill's net income was $750,000.

In keeping with its long-term share repurchase plan, 8,000 shares were retired on July 1. Dow's net income for the year ended December 31, 2018, was $2,700,000. The income tax rate is 40%.

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:

Date Granted	Options Granted			Share Price
	(adjusted for the stock dividend)
December 31, 2016		19,000		$	30
December 31, 2017		14,000		$	39
December 31, 2018		17,500		$	38

The market price of the common stock averaged $38 per share during 2018.

On July 12, 2016, Dow issued $1,000,000 of convertible 10% bonds at face value. Each $1,000 bond is convertible into 20 common shares (adjusted for the stock dividend).

Required:
Compute Dow's basic and diluted earnings per share for the year ended December 31, 2018. (Enter your answers in thousands.)

Answer 1

1. Basic EPS:

Step 1 : Calculate weighted average no of shares-

Jan 1- Dec 31 - 720,000 * 12/12 * 1.04 = 748,800

Feb 28 - Dec 31 = 66,000 * 10/12 *1.04 = 57,200

Jan 1 - July 1 = 8000 *6/12 = 4000

Total weighted average shares = 748,800+57,200 - 4000 = 802,000

Income available to common stockholders = 2,700,000 - 81,000 = 2,619,000

Basic EPS = 2,619,000 / 802,000 = $3.26 per share

2. Diluted EPS:

The stock options issued on Dec 31,2016 are only counted for dilutive shares since the exercise price is less than the market price.

Money received on issue of stock options = 30*19,000 = 570,000

Shares repurchased at current market price = $570,000 /$ 38 = 15,000

Increase in no of shares = 19,000 - 15,000 = 4,000 shares

Potential Bond conversion stock = (1,000,000 /1000) *40 = 40,000

Diluted Shares = 40,000+ 4,000 + 802,000 = 846,000

Diluted Earnings =2,700,000 - 81,000 + [100,000 *(1-0.4)] / 846,000

= $ 3.167 per share