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MARBNYC
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| Posted: 06 Mar 2010 at 15:59 | IP Logged
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hey guys, I'm having some difficulty understanding how they come up with the denominator (for the Diluted EPS formula) in the solution for the following problem:
On Jun 30, 2006, Lomond Inc issued twenty $10k, 7% bonds at par. Each bond was convertible into 200 shares of common stock. On Jan 1, 2007, 10k shares of common stock were outstanding. The bondholders converted all the bonds on Jul 1, 2007. The following amounts were reported in Lamond's income statement for the year ended Dec 31, 2007:
Revenues 977k
Operating Expenses (920k)
Interest on Bonds (7k)
Income before income tax 50k
Income Tax at 30% (15 k)
Net Income 35k
What's Lamond's 2007 diluted EPS?
Answer: $2.85
BEPS = 35k / (1/2) 10k + (1/2) 14k = 2.92
Diluted EPS = 35k + 4.9k / 12k + 2k = 2.85
Here is where I'm stuck, why would the denominator show 12k + 2k, rather than 10K + 4k.
I calculated WACSO for Basic EPS as follows
1/1/07 10000 x 6/12 = 5,000
7/1/07 (10000+4000) x 6/12 = 7,000
thus WACSO = 5k + 7k = 12,000
For the Diluted EPS i calculated WACSo slightly different, by omitting the bond conversion.
1/1/07 10000 x 12/12 = 10,000
Thus WACSO = 10000
And the denominator for DEPS = WACSO + additional shares from bond conversion = 10,000 + 4,000 = 14,000
Thank you for your time and for reading this far....will check back in again later...
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Marlene
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ael719
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| Posted: 06 Mar 2010 at 17:37 | IP Logged
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"The bondholders converted all the bonds on Jul 1, 2007."
Remember, the conversion actually happened. So its recorded no matter what in this situation. Also, you shouldassume conversion at the beginning of the period (or at the time the
convertible security is issued, if later.
**** FIXED - "assume conversion of the PCS at the beginning of the period or at the
date of issuance, whichever is LATER" to "assume conversion at the beginning of the period (or at the time the convertible security is issued, if later"
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MARBNYC
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| Posted: 06 Mar 2010 at 18:01 | IP Logged
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Right. They converted all the bonds, therefore are no other instruments outstanding that could dilute earnings per share outstanding at year end. So why ask to solve for DEPS?
My original question was why would the denominator be broken down into 12k + 2k? if wacso = 10,000 and excluding the dilution of the bonds. And the denominator for DEPS = wacso + any dilutive instruments, in this case the 4000 shares from the conversion of the bonds. Then denominator for EPS = 10000 + 4000. Although I have the right total answer; 14,000, Becker lands to the same answer differently. They added 12,000 to 2,000. I see the 12000 is the wacso for BEPS, but where does the 2,000 come from?
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Marlene
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ael719
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| Posted: 06 Mar 2010 at 20:10 | IP Logged
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DEPS = BEPS + Effects of PCS
BEPS = 35,000 / 12,000
DEPS = 35,000 + Bond Interest Expense / 12,000 + Conversion of bonds
into stock
DEPS = 35,000 + (10,000 x 20 x .07 x 6/12) / 12,000 + (4,000 x 6/12)
DEPS = 35,000 + 4,900 / 12,000 + 2,000
The bonds are dilutive under the "if converted" method. DEPS accounts
the effect of all dilutive potential common shares that were outstanding
during the period and the bonds are assumed converted on 1/1 because
they are dilituve and because the bonds were actually converted on 7/1.
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MARBNYC
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| Posted: 07 Mar 2010 at 20:17 | IP Logged
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Quote:
| the bonds are assumed converted on 1/1 because they are dilituve |
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if the bonds or the 4000 shares generated from exercising the bonds were assumed converted as of 1/1, then wouldn't the weighted average be
..........# shares.....Period...Weg.Avg
1/1 10,000 +4000 x 12/12 = 14,000
You showed:
DEPS = 35,000 + 4,900 / 12,000 + 2,000
your work shows the 2000 come from weighting the shares of the bond conversion for the time of the year they were outstanding (Jul 1st;6/12) but the 12,000 already include the shares for the second half of the year....now i see what's happening here, the dilute shares are assumed to be outstading as of the beggining of year, that means when computing the w.a the 4000 must be weighted by 12 months (a full year), whereas I had only done it for the second half of the year; reason why the solution simply adds the first half of the year (2000x6/12) to make it a full year w.a ...thank you once again! :)
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Marlene
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Topic: Weighted Average - WACSO
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