Earnings Per Share (EPS)

1. What is (basic) EPS? When do you show it? Why is it such a closely followed statistic?

Net income - Cumulative pref. div. - Non-cumulative pref. div. (only if declared)
Weighted Average # of Common Shares Outstanding

2. Weighted Average # of Common Shares Outstanding.

Adjusts common shares outstanding taking into account all share transactions. The number is
presented in terms of the end of the period units.
• Shares issues and transactions are weighted according to the date issued.
• Share issues outstanding & share issues or repurchases occurring prior to a stock
dividend or split: must be restated to take effect of a stock dividend or split
• Shares issued or repurchased during the period after a stock dividend or split: are
treated as individual transactions

Example:
Jan 1, 100,000 shares outstanding.
Feb 1 20,000 more common shares issued.
July 1, 10% stock dividend declared
Oct 1, 10,000 shares repurchased
Nov 1, 3 for 1 stock split

Date Event # shares o/s Equiv # of weight Weighted

Shares Average
1/1 Beginning 100,000 x 3.3 12/12 330,000

2/1 Issue + 20,000 x 3.3 11/12 60,500

7/1 Stock div 110% x 3.3

10/1 Repurchase -10,000 x3 3/12 7,500

11/1 Split 300% x3

Total Equivalent shares 383,000

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3. What is DEPS? What are some examples of dilutive instruments?

BEPS numerator + Imputed savings from dilutive instruments

BEPS denominator + Common shares from dilutive instruments

- Stock options & warrants

- Convertible preferred shares

- Convertible bonds

4. Anti-dilutive securities

5. What insights does DEPS give to common shareholders?

EPS Demo:
Shareholders’ equity at Jan 1:

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Preferred:1,000,000 authorized, 400,00 issued and o/s, $4 per share dividend, cumulative,
convertible at the rate of 1 Pfd to 5 Common.
Common:5,000,000 authorized, 800,000 issued and o/s, no par.
R/E : deficit of $1,200,000

No dividends declared for 3 years. No convertible bonds are o/s, 10,000 bonds with face
values of $100 each. Convertible at the rate of 1 bond to 20 common shares. Interest expense
on the convertible bonds was $100,000 in the year.

Stock options o/s:

“A” 40,000 options to purchase Common at $4 per share
“B” 50,000 options to purchase Common at $5 per share
Average share price: $4.90
Net Income $1,234,000
Tax rate 40%
Required: prepare EPS
BEPS: $1,234,000 – ($4 x 400,000) = $(0.46)/share
800,000

DEPS: dilutive factors:

Senior shares: $4 available now with 5 more common = $0.80 /share

Bonds: after tax benefit of saved interest / increase in shares

$100,000 x ( 1 – 0.40) / (10,000 x 20) = $0.30 /share

Stock options “A” : (40,000x$4)/$4.90 = 32,653 shares

40,000 – 32,653 = 7,347 additional shares.

Stock options “B”: “Out of the money” - ignore

Ignore all except Option “A”

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DEPS: $1,234,000 – ($4 x 400,000) = $(0.45)/share
800,000 + 7,347

+++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
Assume net income = $ 2,234,000

BEPS: $2,234,000 – ($4 x 400,000) = $0.79 share now bond is NOT anti!
800,000

Always add “in the money” options first – they will always be dilutive as long as BEPS is +

DEPS: $2,234,000 – ($4 x 400,000) = $0.785/share

800,000 + 7,347

Now add dilutives:

DEPS: $2,234,000 – ($4 x 400,000) – ($100,000 x .6) = $0.69/share
800,000 + 7,347 + (20 x 10,000)

Adding the senior shares now would INCREASE DEPS - so DON’T

Do questions 1,2,3

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Question #1 Earnings Per Share
On January 1, 20x1, Roma Ltd. had the following shareholders’ equity:

Class A Preferred, 900,000 authorized, 330,000 issued and outstanding; no par value; $3 per
share cumulative dividend; each class A share convertible to 8 class B common shares
(protected against stock splits and dividends); issued at $15 per share.

Class B Common, 2,000,000 authorized, 670,000 issued and outstanding; no par value; issued
at $4 per share.

Retained earnings: $3,445,000.

No dividends had been declared on either class of shares for the past three years.

At the start of the year, the company granted 25,000 stock options to the president. Each
option gives the holder the right to purchase a Class B share at $3. These stock options were
exercisable immediately. The options are protected against stock splits and dividends.

During the year, the following occurred:

a. Net income for the year was $1,357,000.

b. On March 31, Roma issued $100,000 of 8% (paid annually) convertible bonds with a
10 year life for $102,000 (note: bonds sold for greater than face due to the conversion
feature). Bonds of similar risk and duration (but without the conversion feature) were
yielding 9% at the time. Each $100 bond is convertible to 5 Class B common shares.
The conversion feature is protected against any stock splits or dividends. Roma’s
marginal corporate tax rate is 30%.

c. On April 1, 20x1, the company sold 45,000 of the common class B shares for $17.50
per share. Another 75,000 common class B shares were issued on December 1 for
$17.75 per share.

d. On July 1, the company declared a class B common stock dividend of 40% to the class
B shareholders. Conversion privileges of the class A preferred shares were restated to
reflect the stock dividend, as were all outstanding stock options and convertible bonds.

e. The average price of Roma’s Class B shares was $15 for 20x1 (adjusted for the stock
dividend).

Required:
Prepare the EPS section of the financial statements.

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Basic EPS

1,357,000 - = $ = $ per share

*

Event # of Equiv Weight Weighted

Shares # of Average
O/S shares
January 1

Diluted EPS (Dilutive Tests)

Preferred Shares
= =$ per share

Stock options

Bonds
= = $ per share

Diluted EPS (Presentation)

= =$ per share

= =$ per share

STOP!!!! At $0.84 cents, the bonds are now ANTI-DILUTIVE. DEPS is presented as $ 0.29.

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Question #2 Earnings Per Share
Here are excerpts from Kirkland Inc.’s financials for the year ended December 31, 20x2:

Net income $10,300,000

From the Balance Sheet:

Long-term bonds
10% convertible bonds; mature on December 31, 20x11 9,000,000
Discount on bonds (???)

Shareholders’ Equity
Preferred Shares
Convertible; no-par value; $0.20 cumulative annual
dividend; 600,000 issued and outstanding 1,350,000

Common Shares
No-par value; 3,320,000 issued and outstanding 13,700,000

Warrants 425,000

Other information for 20x2:

a. Cash dividends of $.12 per common share were declared and paid each quarter.
b. 10% convertible debentures with a principal amount of $10,000,000 were issued on
January 1, 20x2 for gross proceeds of $ 9,200,000. The bonds have a 10 year life and
pay interest annually each December 31. Bonds of similar risk and duration but without
a conversion feature were selling for $ 8,869,955 (a yield of 12%). Each $100
debenture is convertible into 2 common shares. On December 1, 20x2, 10,000 $100
bonds (total face value of $1,000,000) converted to common shares (note: net income
properly reflects the conversion of the bonds).
c. The 600,000 convertible preferred shares were issued for assets in a purchase
transaction of April 1, 20x2. As the preferred shares were issued in April, holders will
get the 3/4 of the full annual dividend. The dividend was declared and paid on
December 31, 20x2. Each preferred share is convertible into one common share.
d. Warrants to buy 500,000 common shares at $60 per share for a period of five years
were issued along with the convertible preferred shares mentioned in (c).
e. At the end of 20x1, 3,300,000 common shares were outstanding. On December 1,
20x2, 20,000 shares were issued on the conversion of bonds (see (b) above).
f. The company’s marginal tax rate is 40%.
g. The average price of common shares during the year was $73.

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Required:
Prepare the EPS section of the financial statements.

Basic EPS
1
$ 10,300,000 - = $ 3.09
2

1
Preferred dividends:
2
Weighted average common shares outstanding for 20x2:

January 1
December 1

Diluted EPS

1. Preferred shares = = =

2. Warrants

3. Bonds
1
= $ =
2

1
Imputed Income on Bond:
$ 9m still o/s
($8,869,955 x 90% x 12%) x 12/12 x (1 - 0.40) = 574,773
$1m conversion
($8,869,955 x 10% x 12%) x 11/12 x (1 - 0.40) = 58,542
633,315
2
Deemed Number of Issued Shares:
($9,000,000/100 x 2 x 12/12) + (1,000,000/100 x 2 x 11/12)
180,000 + 18,333 = 198,333

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 Calculation Income Shares EPS
Basic $10,210,000 3,301,667 3.09
Warrants 66,781
10,210,000 3,368,448 3.03
Preferred shares 90,000 450,000
$10,300,000 3,818,448 2.70
Bonds 633,315 198,333
10,933,315 4,016,781 2.72*

* The bonds are ANTI-DILUTIVE; therefore, diluted EPS must be reported at $ 2.70

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Question #3 Earnings Per Share
Serpico Ltd. has a year-end of December 31st. The company had the following opening
account balances at January 1, 20x2.

Bond Payable
(Each $1,000 is convertible to 30 common shares) $ 4,000,000
Discount on Bond (300,000)
$ 3,700,000
Preferred Shares
No par value; cumulative $3 annual dividend (paid quarterly)
200,000 shares issued and outstanding $ 3,000,000
(Each preferred share is convertible to one common share)

Common Shares
5,000,000 authorized, 1,000,000 issued, no par value $ 20,000,000

Treasury Shares
200,000 common shares $ (3,200,000)

Notes to the financial statements reveal that there was $1,200,000 (200,000 x $3 x 2 years) of
preferred dividends in arrears related to 20x0 and 20x1. The bond was issued when the
effective rate of interest was 9% (coupon rate of 8%). Net income for 20x2 was $5,103,000.
The tax rate is 30% and the average common share price for the year was $19.

In 20x0, Serpico Ltd. issued 410,000 stock options [Plan A] to executives with an exercise
price of $17. Also in 20x0, Serpico Ltd. issued 20,000 stock options [Plan B] to other
employees with an exercise price of $24. All options are currently outstanding and
exercisable. The company has a December 31 year-end.

During 20x2, the following events occurred:

• March 1, re-issued 150,000 treasury shares at $16 each.
• April 1, 40,000 preferred shares converted to common.
• July 1, re-issued the balance of the treasury shares at $18 each.
• October 1, issued 800,000 common shares at $21 each.
• December 30, declared a $1.20 cash dividend on the common stock. These dividends
were paid on January 15, 2003.

Required:
Prepare the EPS section of the financial statements for 20x2.

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BEPS
Event # of shares Equiv shares Wt Total
Opening balance 800,000
(net of treasury)
March 1 +
=
April 1 +
=
July 1 +
=
October 1 +
=

Total

BEPS = $5,103,000

= =

DEPS

1) Stock Options

Plan A

Plan B
These are not in the money (i.e., exercise price is greater than average common share price
for the year) and are therefore ignored.

2) Preferred Shares:

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3) Bonds

Income Shares
Basic EPS 4,593,000 / 1,180,000 = $3.89

Step 1) Options 43,158

4,593,000 / 1,223,158 = $3.76

Step 2) Bonds 233,100 120,000

4,826,100 / 1,343,158 = $3.59

Step 3) Preferred 510,000 170,000

5,336,100 1,513,158 = $3.53

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