17-9

Question 1

Calculate basic earnings per share for 2014.

(Preferred dividends were not declared in 2014.)

Answer 1

• you subtract preferred dividend (only for cumulative shares (!) because it is a current liability) even though the probem states clearly that dividends for preferred were not declared.

Don’t include dividends in arrears.

Question 2

Calculate diluted earnings per share for 2014

Answer 2

Individual earnings per share calculations are done for each potentially dilutive security to determine if the securities are in fact dilutive, when compared to basic earnings per share of $0.85. Only dilutive securities will be used in the calculation of diluted earnings per share. Each will be used in sequence, from most dilutive to least dilutive, in order to arrive at the most diluted earnings per share result. In the ranking of securities, options will be used first if they are in the money (exercise price of $12 is below the average market price $18).

Question 3

How you calculate dilution for options

Answer 3

Treasury stock options:

1. calculate how many more shares can be issued by exercising the options and what the PROCEEDS would be
2. With the PROCEEDS calculate how many you can buy back at the average market price (most likely it will be quite a bit less shares)
3. The result is the incremental shares outstanding that will be add up to the # of shares in the calculation (Income/# shares)

Options affect only the denominator!

Question 4

How you calculate dilution for BONDS

Answer 4

You need to find out how much money you would save in interest expense => adds up to your income

1. maturity value x stated rate = Interest expense
2. calculate the tax you’d have paid for the extra income

(1- tax rate) or multiply by the tax rate and subtract that from the result

3. calculate the # of shares that would result from conversion
4. calculate EPS with the numbers just to see if it is dilutive or not

Question 5

Figuring out how and what you will put first on the schedule for the diluted EPS

Answer 5

Have a separate calculation for each convertible security and compare always with the basic EPS. Whichever is the most dilutive (the result is the smaller compared with basic EPS) goes first

Question 6

The 6% convertible bonds were issued on July 1, 2014,

Answer 6

(!) be careful when the bond was issued so you prorate the interest expense you would have had.

Same calculation, except you pro-rate the interest expense for 6 months and then you subract taxes.

Question 7

Convertible preferred shares and diluted EPS

Answer 7

By converting preferred shares 2 things happen:

1. You save the money you’d have paid on dividends =. numerator effect as you don’t need to subtract that amount from the Net Income
2. you increase the number of shares

After calculating the result of this conversion, again calculate the EPS just for that and compare it with basic EPS

Question 8

Schedule for calculating diluted EPS

Answer 8

Diluted

Earnings

Per Share Income Shares EPS
basic

options

4% bond

preferred shares

Have a total after each calculation, so you have a running balance of the diluted EPS. this is very useful as going down from the most dilutive to the least, you might find out that one at the bottom is not dilutive anymore (preferred shares in this case)

The preferred shares are therefore excluded from the diluted earnings per share calculation