Question

The accountant of Skywalker Corp. (this is a public company) reviewed the draft of the 2150 year end financial statements and had found that it was missing essential information to find the correct calculations of Basic EPS and Diluted EPS.

On January 1, 2150, Skywalker Corp. started the year with 20,000,000 common shares outstanding.

On February 28, issued 3,000,000 common shares.

On April 31, Skywalker Corp. bought back and retired 5,000,000 common shares.

On December 1, Skywalker Corp. issued a 25% stock dividend.

Prior to 2150, the accountant knew that in the Shareholder's Equity section of 2149, Common Shares had unlimited number of shares authorized, with 10,000,000 shares issued and outstanding.

Preferred shares, 17% cumulative, non-convertible shares, 2,000,000 shares issued and outstanding.

The preferred shares have a par-value of $4 per share.

Other information that was noted:

Skywalker Corp. had 10,000 call options issued. Each option was exercisable for one share at $450

The average market price of Skywalker Corp.'s common shares during 2150 was $650.

Skywalker Corp. had 11% convertible bonds. Each $1,000 bond is convertible into 2 common shares.

The value of the bonds was $10,000,000.

Skywalker Corp. had accounting income (before taxes) of $42,500,000 and taxable income of 34,000,000. The tax rate for Skywalker Corp. was 30%.

Required:

1. Calculate the weighted average number of shares.

2. Calculate the basic earnings per share.

3. Calculate the diluted earnings per share.

Answer 1

1.weighted average number of shares

• Wtd average= shares * weighting
• adjustment to stock divident= Wtd average * (1+divident percentage)=Wtd average * 1.25
• weighting= months after transaction /12

date	shares	weighting	Wtd average	adjustment to stock divident
jan 1	20,000,000 outstanding	12 /12	20,000,000	25,000,000
feb 28	3,000,000 shares issued	10/12	2,500,000	3,125,000
april 31	retired 5,000,000 shares	8/12	(3,333,333.33)	(4,166,666.67)
Total= 25,000,000 + 3,125,000- 4,166,666.67= 23,958,333.33

weighted average number of shares=23,958,333.33

2.basic earnings per share= net income available for common stockholders / weighted average number of shares

Net income= before tax accounting income *(1- tax rate)= 42,500,000 *(1-.3)= 42,500,000 *0.7=29,750,000

Divident to preffered stock holders= no.of pref stock * par value * rate of divident=2,000,000 * 4 * 0.17=1,360,000

net income available for common stockholders=Net income -Divident to preffered stock holders= 29,750,000 -1,360,000= 28,390,000

basic earnings per share= net income available for common stockholders / weighted average number of shares=28,390,000 / 23,958,333.333= 1.1849

Basic earnings pershare=1.1849

3.

Diluted earnings per share assume that all potential common shares are exercised at the begining of the periode or at the date they issued.

• if 10,000 call options exercised at the begining at 450, company will use this fund to byback shares from market

cash recieved= 10,000 * 450 =4,500,000

shares repurchased= cash recieved / market price of stock= 4,500,000 /650=6923.1

net increase shares= 10,000 - 6,923.1=3,076.9

net increased shares adjusted to stock divident= net increase shares *(1+ divident percentage25%)= 3,076 .9*1.25=3,846.125

• convertion of bond

increase in no.of shares= no.of bonds * 2 ;because each bond can convert in to 2 shares

increase in no.of shares= 2 * 1000 = 2000

increase in no.of shares adjusted to stock divident= 2000 * 1.25=2,500

Conversion of bond also effect numerator in DEPS calculation

interst of the bonds= value of bonds * coupon rate= 10,000,000 * 0.11= 1,100,000

change in income= interst of the bonds * (1- tax rate)= 1,100,000 * 0.7=770,000

Increase in shares adjusted to stock divident will use in calculation of diluted earnings per share

	Income or numerator	weighted avg number of shares	EPS
Basic earnings per share	28,390,000	23,958,333.333	1.1849
Stock options		+3,846.125
Intermediate DEPS	28,390,000	23,962,179.455	1.1847
Conversion of bond	+770,000	+2,500
Intermediate DEPS	29,160,000	23,964,679.445	1.2167

When we calculating DEPS, we should stop calculation when an intermediate DEPS is higher than the previous intermediate DEPS.here conversion of bond is anti dilutive.

Diluted earnings per share= 1.1847