Chapter 16Homework Day 2

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, Lennonauthorized issuance of additional 160,000 c/s shares:

Company A 4/1/08………..Issued 50,000 shCompany B 7/1/08………..Issued 80,000 shCompany 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 andexclusive of the gain

Instructions:Assume 50% tax rate, compute EPS that should appear onf/s of Lennon at 12/31/08. Assume expropriation isEXTRAORDINARY.

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

Net income - p/s dividends----------------------------------Weighted Average Shares of C/S

Dates Outstanding Shares Out Fraction/year Weighted Sh

1/1-4/1 200,000 3/12 50,000Issue 50K

4/1-7/1 250,000 3/12 62,500Issue 80K

7/1-10/1 330,000 3/12 82,500Issue 30K

10/1-12/31 360,000 3/12 90,000

Total Weighted Shares………………………………. 285,000

BOTTOM LINE EPS IS:

$195,000 -$60,000

285,000

= $.47/sh

But the question asked for the proper EPS disclosurewhich 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

6-1-05 Andre Co. and Agassi Co. MERGED to formLancaster Inc.• 800,000 shares issued to complete merger.

April 1, 2007 co. issued an additional 400,000 sh. of stock forcash.

All 1,200,000 shares outstanding on 12/31/07.

Lancaster also issued $600,000, 20 yr, 8% convertible bondsat 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 2007What 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 7/1 sell 8% convertible bonds

$600,000/$1000 = 600 bonds x 40 sh/bond = 24,000 shares

On 4/1 issue 400,000 more c/s shares

Apr 1-Jul 1 1,200,000 x 3/12 = 300,000

Jul 1-Dec 31 1,224,000 x 6/12 = 612,000

Weighted Average Shares…….. 1,112,000 shNOT backdated to 1/1 because theywere JUST sold this year

This is an application of the "if-converted method"

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 THISyear 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

$1,540,000/ $1,100,000

= $1.40/sh

$1,554,400/ 1,112,000

= $1.40/sh

WE ONLY NEED TO SHOW BASIC EPS!

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 DILUTEDEPS.

A. Prepare schedule to compute both BASIC and DILUTEDEPS.

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

$5,000,000 x .07 = $350,000

LOST ON TAX BENEFIT

$360,000 x .35 = $126,000

NETincreasein NI

$360,000 - $126,000 =$234,000

PLUS DISCOUNT AMTZ

.02(5,000,000) = $100,000 DISC

$100,000/10 yrs = $10,000

$350K+10K=$360K

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

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 determineimpact 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 repurchasedfrom 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 onOCT 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 touse 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