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LANI2009
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| Posted: 30 Oct 2010 at 14:12 | IP Logged
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# Poe Co. had 300,000 shares of common stock issued and outstanding at December 31, 1988. No common stock was issued during 1989. On January 1, 1989, Poe issued 200,000 shares of nonconvertible preferred stock. During 1989, Poe declared and paid $75,000 cash dividends on the common stock and $60,000 on the preferred stock. Net income for the year ended December 31, 1989 was $330,000. What should be Poe's 1989 earnings per common share?
Choice "b" is correct. $0.90 earnings per common share.
Net income $330,000
Less: Preferred dividends paid (60,000)
Income available for common stock $270,000
For basic EPS, $60k dividend for preferred stock should be subtracted, right? If yes, in the question, $60k has already been taken out to get NI $330K, why subtract again in the answer?
Thanks for help!
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ccaml
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| Posted: 30 Oct 2010 at 14:28 | IP Logged
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Net Income of $330k is before any dividends paid to shareholders.
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tetsuwangatomu
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| Posted: 30 Oct 2010 at 16:54 | IP Logged
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Please practise the following 7 questions and you will be in good
shape for Diluted EPS Calculation:
Passkey:
Please distinguish NonConvertible Preferred Stocks from Convertible
Preferred Stocks, Please Calculate Basic EPS no matter what and use
calculated Diluted EPS to compare with it and if Diluted one is less
then all right.
Please watch out for Stock options and Stock warrants ones and
make sure you beat the calculations to death.
Best wishes...
==
question 1
The Johnson Company is computing diluted earnings per share for
the current year. The company has convertible bonds outstanding
that have been judged as being anti-dilutive. What is the significance
of anti-dilution?
A The bonds must be included in the computation of diluted earnings
per share.
B Because of the high rate of interest on these bonds, the impact
must be separately disclosed within the computation.
C Inclusion of the bonds in the computation must be made using the
most conservative method.
D Inclusion of the bonds in the computation will cause the reported
figure to increase so that the potential conversion of the bonds should
be excluded.
Answer:
The correct answer was D.
Diluted earnings per share is an attempt to portray a “worse case
scenario”—the possible impact on earnings per share if all convertible
items were to become common stock. Some convertibles, though,
can actually cause the reported figure to increase. Those convertibles
are referred to as “anti-dilutive” and are omitted in computing diluted
earnings per share so that the worse case scenario can be achieved.
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question 2
The Pfeiffer Corporation reports net income in the current year of
$800,000. Pfeiffer had a nonconvertible preferred stock paying
$70,000 in cash dividends. Another $2.00 per share in dividends was
paid to the common stockholders. There are 190,000 shares of this
common stock outstanding throughout the year. In addition, the
company has 20,000 stock options outstanding. For $2, each option
can be converted into one share of common stock. The average price
of the stock during the year was $8. The company has an effective
tax income rate of 20 percent. What is Pfeiffer's diluted earnings per
share (rounded)?
A $3.48
B $3.56
C $3.68
D $3.76
Answer:
The correct answer was B.
Basic earnings per share for this company is $730,000 (net income of
$800,000 less the $70,000 in preferred stock dividends) divided by
the 190,000 shares of common stock or $3.84 per share (rounded).
To convert that figure into diluted earnings per share, the assumption
must be made that the stock options are converted into shares of
common stock. That adds 20,000 shares to the number of common
shares. However, for this conversion to have occurred, cash of
$40,000 ($2 per option times 20,000 options) would have been
received. That money could have been used by the company in
dozens of different ways: buying inventory, funding research and
development, paying off interest bearing debt, and the like. So that
all companies carry out this computation in a similar fashion, the
assumption must be made that this money would have been used to
buy shares of the company’s own stock at its average price for the
year. Based on this assumption, the company would have acquired
5,000 shares of treasury stock ($40,000 cash divided by an average
price of $8 per share). Diluted earnings per share is the $730,000 in
income from basic earnings per share divided by 205,000 shares or
$3.56 per share (rounded). The 205,000 shares comes from the
190,000 shares outstanding for the year plus the 20,000 shares from
the assumed conversion of the stock options less 5,000 shares
reacquired using the cash that would have been generated from the
stock options.
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question 3
For Year One, the Seeger Corporation reports net income of
$520,000. The company has 10,000 shares of nonconvertible
preferred stock outstanding paying $4 per share each year in
cumulative dividends. The company has 300,000 shares of common
stock outstanding throughout the current year. In addition, the
company issued 9,000 convertible bonds at face value several years
ago. Each bond has a face value of $100 and is convertible into 4
shares of common stock. These bonds pay interest of 6 percent per
year. The effective income tax rate is 20 percent. What is diluted
earnings per share (rounded) for Year One?
A $1.50
B $1.52
C $1.56
D $1.60
Answer:
The correct answer was C.
Basic earnings per share for this company is $480,000 (net income of
$520,000 less the $40,000 in preferred stock dividends) divided by
the 300,000 shares of common stock or $1.60 per share. To convert
that figure into diluted earnings per share, the assumption must be
made that the convertible bonds are actually converted. If that took
place, 36,000 shares would be issued (9,000 bonds, each converted
into 4 shares of stock). Logically, though, if the bonds had been
converted into common stock, no interest expense would have been
incurred. That interest must be eliminated along with its tax effect.
With a face value of $900,000 (9,000 bonds having a face value of
$100 each) and an interest rate of 6 percent, that interest is
$54,000. Eliminating the interest would cause taxable income to rise
so that an additional income tax of $10,800 (20 percent rate on the
$54,000) is paid. Conversion of the bonds causes income to go up
$54,000 (to eliminate the interest) and then down $10,800 (to pay
the related taxes). Earnings becomes $523,200 ($480,000 plus
$54,000 less $10,800) and is divided by 336,000 shares (300,000
plus 36,000 from conversion) for a diluted earnings per share of
$1.56 (rounded).
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question 4
A company has 200,000 shares of common stock outstanding on
January 1 of the current year but issues another 40,000 shares on
July 1. In addition, the company has 20,000 shares of preferred stock
that pays a $3 per share dividend each year. These shares can each
be converted into three shares of the company’s common stock. The
company reports net income for the current year of $940,000. It has
an effective tax rate of 30 percent. What is diluted earnings per
share (rounded)?
A $3.29
B $3.36
C $3.40
D $3.42
Answer:
The correct answer was B.
The company had 200,000 shares of common stock outstanding for
the first six months of the year (200,000 times 6 or 1,200,000) and
240,000 outstanding for the final six months (240,000 times 6 or
1,440,000). The weighted average is 220,000 (1,200,000 plus
1,440,000 divided by 12). Basic earnings per share for this company
is $880,000 (net income of $940,000 less the $60,000 in preferred
stock dividends) divided by this 220,000 average or $4.00 per share.
To convert that figure into diluted earnings per share, the assumption
must be made that the convertible preferred shares are actually
turned into common stock. The 20,000 shares of preferred stock
would become 60,000 shares of common stock. In addition, the
$60,000 would not be paid. There is no tax effect associated with the
payment of dividends. As a result, diluted earnings per share is
$940,000 ($880,000 income from basic earnings per share plus
$60,000 in dividends that are eliminated) divided by 280,000 shares
of common stock (220,000 plus 60,000 shares from conversion) for a
diluted earnings per share of $3.36 (rounded).
-
question 5
Officials for the Lexington Company are preparing financial
statements for Year One. The company is reporting net income of
$900,000. The company had 100,000 shares of common stock
outstanding at the beginning of the year but a stock split on October
1 doubled that number to 200,000. In the previous year, the
company issued 10,000 convertible bonds with a face value of $1,000
each that will come due in ten years. Each bond is convertible into 15
shares of common stock (adjusted for the stock split). These bonds
pay 4 percent interest but were sold for 93 percent of face value to
generate a higher interest rate for the buyers. The tax rate for the
company is assumed to be 30 percent. The bond discount is being
amortized by the straight-line method. What should the company
report as its diluted earnings per share (rounded)?
A $3.51
B $3.55
C $3.67
D $3.81
Answer:
The correct answer was A.
In determining earnings per share, stock dividends and stock splits
are assumed to have happened when the computation first began.
Thus, the stock split is handled here as if it took place on January 1
so that the company had 200,000 shares of common stock
outstanding for the entire year. Basic earnings per share is $4.50
($900,000 reported net income divided by these 200,000 shares of
common stock). For diluted earnings per share, the bond must be
assumed as having been converted. Conversion of the 10,000 bonds
would require 150,000 shares of common stock to be issued for a
total of 350,000. However, interest expense would then have not
been recognized. The cash interest of $400,000 (4 percent of $10
million face value) plus the $70,000 straight-line amortization of the
discount (the $700,000 discount spread evenly over the ten-year life
of the bonds) gives interest expense of $470,000. The elimination of
that interest (because of the assumed conversion of the bonds)
causes net income to go up by $470,000. That increase would also
lead to an additional tax expense of $141,000 ($470,000 times 30
percent tax rate). Earnings for this computation is $1,229,000
($900,000 reported income plus $470,000 interest saved less
$141,000 in additional taxes). Thus, diluted earnings per share is
$3.51 ($1,229,000 divided by 350,000 shares of common stock). That
figure is less than the $4.50 basic earnings per share so the bonds
are not antidilutive.
-
question 6
The Pacioli Corporation reports net income for Year One of $800,000.
The company had 155,000 shares of common stock outstanding for
the entire year as well as 90,000 shares of preferred stock. The
common stock was paid $1 per share as a dividend while the
preferred shareholders received $2 per share. The common stock
had an average price for the year of $40 per share while the
preferred stock had an average price of $60 per share. The company
also had 20,000 stock options outstanding for the year. For $10, each
option could be converted into a share of common stock. The
effective tax rate is 25 percent. What should the company report as
its diluted earnings per share (rounded) for Year One?
A $3.54
B $3.65
C $3.77
D $3.81
-
Answer:
The correct answer was B.
Basic earnings per share must be computed first. Net income is
$800,000 but the preferred stock receives $180,000 in dividends
(90,000 shares times a dividend of $2 per share). That leaves
$620,000 in income for the 155,000 shares of common stock for a
basic earnings per share of $4.00. To move to diluted earnings per
share, the stock options are assumed to be converted into common
stock. That immediately increases the number of outstanding shares
on common stock by 20,000 to 175,000. However, the company
receives $10 each or $200,000 in total. Some use for that money
must be assumed. Although in real life, the money might be used in
any one dozens of ways, for this computation, the cash that would
result from conversion is assumed to be used to buy treasury stock.
As the common stock has an average price of $40 per share, the
$200,000 would enable the company to buy back 5,000 shares as
treasury stock ($200,000 divided by $40). Thus, diluted earnings per
share is the $620,000 income assigned to common stock divided by
the 170,000 shares of common stock (155,000 plus 20,000 converted
less 5,000 shares of treasury stock) or $3.65. That figure is less than
the basic earnings per share figure so the stock options are not
antidilutive.
-
question 7
A corporation has 100,000 shares of common stock outstanding and
20,000 shares of nonconvertible preferred stock. A dividend of $1
per share is distributed on the common stock and one of $2 per
share is distributed on the preferred stock. Net income is $400,000
and the tax rate is 20 percent. The corporation also has 10,000
bonds with a face value of $100 and an interest rate of 4 percent.
Each bond is convertible into two shares of common stock although
none have yet been converted. The bonds were issued several
years ago at face value. What is reported as diluted earnings per
share (rounded)?
A $2.80
B $3.27
C $3.33
D $3.60
Answer:
The correct answer was B.
Primary earnings per share must be computed first. That is net
income ($400,000) less the dividends to preferred stock (20,000 x $2
or $40,000) to arrive at the income ($360,000) that can be assigned
to the common stockholders. That is then divided by the number of
outstanding shares of common stock (100,000) to arrive at primary
earnings per share of $3.60. To get to diluted earnings per share,
the convertible bond is then assumed to have been converted. If
converted, 20,000 additional shares would be outstanding (10,000
bonds x 2 shares). If converted, the interest could have been saved
($100 x 4% x 10,000 or $40,000) increasing net income. However,
that rise in income would also have increased the amount of income
tax expense ($40,000 x 20 percent or $8,000). This assumed
conversion brings the income assigned to common stock up to
$392,000 ($360,000 + $40,000 - $8,000) and the number of shares
up to 120,000 so that diluted earnings per shares is $3.27($392,000
divided by 120,000).
__________________
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LANI2009
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| Posted: 30 Oct 2010 at 17:42 | IP Logged
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Thanks so much!
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LANI2009
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| Posted: 30 Oct 2010 at 20:43 | IP Logged
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I got 4 wrong answers and 3 correct answers. Exam is only 20 days away. I doubt I'm gonna pass this first try.
Lucky that I passed BEC in Sep. NOT TOO BAD.
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