1. Chapter 16 Homework Day 2

2. E 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. SIMPLE EPS? 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. = $.47/sh Net income - p/s dividends
Weighted Average Shares of C/S
$195,000
-$60,000
285,000
= $.47/sh
BOTTOM LINE EPS IS:
Dates Outstanding Shares Out Fraction/year Weighted Sh
1/1-4/ , / ,000
Issue 50K
4/1-7/ , / ,500
Issue 80K
7/1-10/ , / ,500
Issue 30K
10/1-12/ , / ,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 ,000 sh x 3/12 = 200,000
Apr 1- Dec ,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 ,000 sh x 3/12 = 200,000
On 4/1 issue 400,000 more c/s shares
Apr 1-Jul ,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 ,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 DILUTED EPS $1,100,000 $1,540,000/ = $1.40/sh 1,112,000
$1,554,400/
1,112,000
= $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
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, , = $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

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, ) =$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, ) = $4.91/sh