Question

P 19–12 EPS; nonconvertible preferred stock; treasury shares; shares sold; stock dividend; options LO19–4 through LO19–8, LO19–10 (Note: This is a variation of P19–12, modified to include stock options.) On December 31, 2015, Dow Steel Corporation had 600,000 shares of common stock and 300,000 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 $400,000 and $75,000 to common and preferred shareholders, respectively, on December 15, 2016. On February 28, 2016, Dow sold 60,000 common shares. In keeping with its long-term share repurchase plan, 2,000 shares were retired on July 1. Dow’s net income for the year ended December 31, 2016, was $2,100,000. 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: The market price of the common stock averaged $32 per share during 2016.

Date Granted Options Granted Share Price

(Adjusted for the stock dividend)

December 31, 2014 8,000 $24

December 31, 2015 3,000 $33

December 31, 2016 6,500 $32

Required: Compute Dow’s earnings per share for the year ended December 31, 2016.

Answer 1

Basic Earning per Share
Basic EPS = Net Income - Preferred Dividend / Weighted Average Shares Outstanding
Weighted Average shares Outstanding	in thousands				Weighted Average shares Outstanding
Date	Number of Shares	Stock Dividend	Total Shares	Weights	Number of shares x Weights
1/1/16	600	24	624	12/12 months	624
2/28/16	60	2.4	62.4	10/12 Months	52
7/1/16	-2		-2	6/12 months	-1
					675
Basic EPS =( $2100 - $75) thousands/ 675 thousands shares	$3.00
Diluted EPS =
Diluted EPS = Net Income - Preferred Dividend + after-taxincome dividendsinterest savings / Weighted Average Shares Outstanding
Weighted Average shares Outstanding	in thousands				Weighted Average shares Outstanding
Date	Number of Shares	Stock Dividend	Total Shares	Weights	Number of shares x Weights
1/1/16	600	24	624	12/12 months	624
2/28/16	60	2.4	62.4	10/12 Months	52
7/1/16	-2		-4	6/12 months	-1
Exercise of options (calculated below)			2		2
				Total number of shares	677	shares
Diluted EPS = ($2100 - $75 Thousands )/677 thousands shares	$2.99
Date	Granted Options	Granted Share Price	Market Price
	(adjusted for the stock dividend)
12/31/14	8000	$24	$32	Exercised
12/31/15	3000	$33	$32	antidilutive
12/31/16	6500	$32	$32	not antidilutive, neither dilutive
The options issued in 2014 are considered exercised for 8,000 shares because the exercise price ($24) is less than the 2016 averagemarket price of $32
Proceeds received upon exercise ($24 x 8,000) =	192000
Shares repurchased at current market price = $192,000/$32	6000	shares
Net increase in # shares = 8000 -6000	2000