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Chapter 16 Homework Day 2

Chapter 16 Homework Day 2. E 16-18 Simple EPS. 1-1-08 Lennon Industries had the following stock outstanding: 6%, cumulative , p/s, $100 par , issued/out 10,000 sh.. $1,000,000 C/S, $10 par , issued/out 200,000 sh…………………. $2,000,000.

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Chapter 16 Homework Day 2

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  1. Chapter 16Homework Day 2

  2. E 16-18 Simple EPS

  3. 1-1-08 Lennon Industries had the following stock outstanding: 6%, cumulative, p/s, $100 par, issued/out 10,000 sh.. $1,000,000 C/S, $10 par, issued/out 200,000 sh…………………. $2,000,000 In order to acquire net assets of 3 smaller companies, Lennon authorized issuance of additional 160,000 c/s shares: Company A 4/1/08………..Issued 50,000 sh Company B 7/1/08………..Issued 80,000 sh Company C 10/1/08……… Issued 30,000 sh On May 14, 2008 Lennon realized $90,000 (before tax) insurance gain on expropriation of investments bought in 94. On 12/31/08 Lennon recorded NI of $300,000 before tax and exclusive of the gain

  4. Instructions: Assume 50% tax rate, compute EPS that should appear on f/s of Lennon at 12/31/08. Assume expropriation is EXTRAORDINARY. SIMPLE EPS? Net income - p/s dividends ---------------------------------- Weighted Average Shares of C/S $300,000 (given) - ($300K * .50 tax) = $150,000 NI after tax and before E Gain $150,000 + ($90,000 E Gain - ($90,000 x .50 tax)) =$195,000 after tax amount

  5. Net income - p/s dividends ---------------------------------- Weighted Average Shares of C/S 10,000 sh x $100 par x 6%= $60,000

  6. Net income - p/s dividends ---------------------------------- Weighted Average Shares of C/S $195,000 -$60,000 = $.47/sh 285,000 BOTTOM LINE EPS IS: Dates Outstanding Shares Out Fraction/year Weighted Sh 1/1-4/1 200,000 3/12 50,000 Issue 50K 4/1-7/1 250,000 3/12 62,500 Issue 80K 7/1-10/1 330,000 3/12 82,500 Issue 30K 10/1-12/31 360,000 3/12 90,000 Total Weighted Shares………………………………. 285,000

  7. But the question asked for the proper EPS disclosure which shows a breakdown: EPS before extraordinary gain but after tax ($150,000 - $60,000)/285,000 = .31/sh EPS for extraordinary gain net of tax $45,000/285,000 =$.16/sh Bottom line EPS……… $.47

  8. Exercise 16-21

  9. 6-1-05 Andre Co. and Agassi Co. MERGED to form • Lancaster Inc. • 800,000 shares issued to complete merger. • April 1, 2007 co. issued an additional 400,000 sh. of stock for • cash. • All 1,200,000 shares outstanding on 12/31/07. • Lancaster also issued $600,000, 20 yr, 8% convertible bonds • at par on 7/1/07. • Each $1000 bond converts to 40 shares of c/s at any interest date. No bonds converted to date. After-tax NI $1,540,000 (tax rate of 40%)

  10. a1. For 2007 What no. of shares should be used for BASIC EPS? Jan 1 - Apr 1 800,000 sh x 3/12 = 200,000 Apr 1- Dec 31 1,200,000 sh x 9/12 = 900,000 1,100,000 sh

  11. a2. What no. of shares should be used for DILUTED EPS? Begin the same way: Jan 1 - Apr 1 800,000 sh x 3/12 = 200,000 On 4/1 issue 400,000 more c/s shares Apr 1-Jul 1 1,200,000 x 3/12 = 300,000 On 7/1 sell 8% convertible bonds $600,000/$1000 = 600 bonds x 40 sh/bond = 24,000 shares This is an application of the "if-converted method" Jul 1-Dec 31 1,224,000 x 6/12 = 612,000 Weighted Average Shares…….. 1,112,000 sh NOT backdated to 1/1 because they were JUST sold this year

  12. b. What are the earnings figures to be used for calculating: 1. BASIC EPS $1,540,000 net income after tax (given) *There are no preferred dividends. b. DILUTED EPS Do the “WHAT IF CONVERTED” method regarding the bonds. SAVE HOW MUCH BOND INTEREST? $600,000 x .08 = $48,000 x 1/2 (because they were issued THIS year mid-way through year). = $24,000 interest savings

  13. b. DILUTED EPS Save $24,000 interest WHAT IS THE LOST TAX BENEFIT? $24,000 x .40 = $9,600 WHAT IS THE NET CHANGE IN NI? +$24,000 - $9,600 ------------ $14,400 WHAT IS THE DILUTED NI? $1,540,000 + $14,400 = $1,554,400

  14. BASIC EPS $1,100,000 $1,540,000/ = $1.40/sh DILUTED EPS 1,112,000 $1,554,400/ = $1.40/sh WE ONLY NEED TO SHOW BASIC EPS!

  15. E 16-22

  16. Simon Corp. issued 10-yr, $5,000,000 par, 7% callable, convertible, subordinated debtenures on 1-2-07 • Bonds have par of $1,000 (annual interest). • Conversion ratio 14:1 (now) • In two years it increases to 18:1 • Were sold AT 98. (St Line Discount Amtz). • Effective tax rate 35%. • NI for 07 was $9,500,000 • 2,000,000 shares outstanding during entire year. A. Prepare schedule to compute both BASIC and DILUTED EPS.

  17. A. Prepare schedule to compute both BASIC and DILUTED EPS. BASIC EPS: Net income - p/s dividends ----------------------------------- Weighted Average Shares 2,000,000 shares outstanding entire year There aren’t any in part a $9,500,000 (given) - 0 2,000,000 shares = $4.75/sh

  18. Still part A. DILUTED EPS WHAT IF bonds were converted? SAVE ON BOND INTEREST PLUS DISCOUNT AMTZ $5,000,000 x .07 = $350,000 .02(5,000,000) = $100,000 DISC $100,000/10 yrs = $10,000 LOST ON TAX BENEFIT $360,000 x .35 = $126,000 $350K+10K=$360K NET increase in NI $360,000 - $126,000 =$234,000

  19. Still part A. DILUTED EPS WHAT IF bonds were converted? Would there be any change in the no. of shares? $5,000,000 of bonds/$1000face = 5,000 bonds 5,000 x 18 (most conservative) = 90,000 new shares $9,500,000 + $234,000 ------------------------------ 2,000,000 + 90,000 = $4.66

  20. Part B: What if the security was PREFERRED STOCK? How would the schedule change? It would look like this: $9,500,000 - $0 (because they wouldn’t be taken then) ---------------------------------------------------------------------- 2,000,000 + 90,000

  21. E 16-24

  22. Venzuela Co. NI for 07 is $50,000. • POTENTIAL DILUTERS • 1,000 options issued during 06 • Each exercisable for one share at $6. • None exercised • 10,000 c/s shares outstanding during 07. • Avg market price of stock during 07 is $20/sh. Compute DILUTED EPS

  23. Compute DILUTED EPS Use the TREASURY STOCK METHOD to determine impact of options converting. Shares of c/s produced upon exercise….. 1,000 Proceeds from sale of stocks on option 1000 x 6 = $6,000 Treasury shares that COULD be repurchased from sale proceeds……… $6000/$20 = 300 Net increase in shares from option exercise… 700 DILUTED EPS: $50,000/(10,000+700) =$4.67

  24. B. Assume same facts except that 1000 options were issued on OCT 1 07 (rather than in 06). Avg. mkt. price in last three mo. still $20/sh. We can’t pretend that they were exercised on 1/1. Have to use 10/1 instead. * This CHANGES the addition to weighted shares Remember we had 700 additional net shares x 3/12 (three months) 175 increase in shares $50,000/(10,000+175) = $4.91/sh

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