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 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

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

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

= $.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 1/1-4/1 200,000 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

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

Exercise 16-21

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%)

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

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

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

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

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!

E 16-22

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.

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

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

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

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

E 16-24

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

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

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