In: Accounting
Dunbar Company had 1,000,000 shares of $1 par value common stock outstanding at January 1, 2015. On July 1, 2015, the company issued 100,000 additional shares of common stock. In addition, at December 31, 2015, 90,000 shares were issuable upon exercise of executive stock options which require a $40 cash payment upon exercise. The average market price during 2015 was $50.
Dunbar Company also has two convertible securities. There are 10,000 convertible bonds with a face amount of $1,000, interest rate of 6% and convertible into 20 shares of common stock and 100,000 shares of 5%, $50 par value convertible preferred stock, convertible into 2 shares each.
During 2015, Dunbar Company’s net income was $24,000,000 and all preferred stock dividends were declared and paid. The company’s tax rate is 40%.
Instructions
Compute the diluted earnings per share for 2015.
Solution:
Weighted average shares for 2015 = (1000000*6/12) + (1100000*6/12) = 1050000 shares
Earning available for equity shareholders for 2015 = Net Income - Dividend to Preferred stock
= $24,000,000 - ($5,000,000 * 5%) = $23,750,000
Basic EPS = Earning for equity shareholders / Weighted average outstanding shares = $23,750,000 / 1050000 = $22.619
Computation of Diluted EPS:
Amount to be paid for stock option = 90000*40 = $3,600,000
Value of option in current shares = Amount paid to exercise option / Current market price = $3,600,000 / 50 = 72000 shares
Diluted shares = Option issued - Value of option in current shares= 90000 - 72000 = 18000
Nos of shares to be issued for convertible bonds = 10000*20 = 200000 shares
Nos of shares to be issued for preferred stock = 100000*2 = 200000 shares
Total weighted average outstanding shares in future = 1050000 + 18000 + 200000+200000 = 1468000 shares
In future Net income available for equity shareholder will be increase by Interest payment to bond holders net of tax and preferred dividend.
Interest on bond after tax = $10,000,000 * 6% (1-0.40) = $360,000
Preferred dividend = $250,000
Future available earnings for equity shareholders = $23,750,000 + $360,000 + $250,000 = $24,360,000
Diluted EPS = $24,360,000 / 1468000 = $16.594 per share