On December 31, 2017 Dow Steel Corporation had 800,000 shares or convertible pre

Question

On December 31, 2017 Dow Steel Corporation had 800,000 shares or convertible preferred stock issued and outstanding. Dow issued a 4% common st dividends of $600,000 and $89,000 to common and preferred shareholders, respectively, on of common stock and 50,000 shares of 8%, noncumulative ock dividend on May 15 and paid cash December 15, 2018 On February 28, 2018, Dow sold 75,000 Cable Company, another 20,000 shares (already adjusted for the stock dividend) are to be issued to former hareholders on December 31, 2019, if Merill's 2019 net income is at least $700,000. In 2018, Merill's net income was common shares. Also, as a part of a 2017 agreement for the acquisition of Mrrill Merill $830,000 In keeping with its long-term share repurchase plan, 4,000 shares were retired on July 1. Dow's net income for the year ended December 31, 2018, was $3100,000. The income tax rate is 40%. As part of an incentive compensation plan, Dow granted incentive stock options to division managers at December 31 of the current and each of the previous two years. Each option permits its holder to buy one share of common stock at an exercise price equal to market value at the date of grant and can be exercised one year from that date. Information concerning the number of options granted and common share prices follows: Date Granted Options Granted (adjusted for the stock dividend) 27,000 22,000 25,500 Share Price December 31, 2016 December 31, 2017 December 31, 2018 $ 46 $ 55 S 54 The market price of the common stock averaged $54 per share during 2018. On July 12, 2016, Dow issued $600,000 of convertible 10% bonds at face value. Each $1,000 bond is convertible into 35 common shares (adjusted for the stock dividend) Required: Compute Dow's basic and diluted earnings per share for the year ended December 31, 2018. (Enter your answers in thousands.) Numerator Denominator Earnings per share Dow's basic Dow's diluted

Explanation / Answer

The formula for Earnings Per Share (EPS) is as follows:

EPS= Net Income / Weighted average Common stock outstanding

Net income = Income - cash dividend paid to preference stockholders

                  = $3100,000 - $89,000 = $3011,000

Weighted Average Common Stock Outstanding =

1/1/2018 - 12/31/2018: 800,000 x 12/12 x 1.04 (adjusted for stock dividend) = 832,000

2/28/2018 - 12/31/2018: 75000 x 10/12 x 1.04 (adjusted for stock dividend) = 65,000

7/1/2018 - 12/31/2018: - 4000 x 6/12 (already adjusted for stock dividend) = -2,000

(this is negative since it is shares retired)

Weighted avergage common stock outstanding = 832000 + 65000 - 2000 = 895,000

EPS = $3011,000 / 895,000 = $3.36

Diluted EPS: Using the treasury stock method:

Net income = $3011,000 - after-tax interest savings

                  = $3011,000 - ($6000 x (1-0.4))   <$6000 is the interest on the debentures and 0.4 is tax rate>

                  = $ 3011,000 - $3,600 = $3007,400

Weighted average no of shares: 895,000 + exercise of options of 4,000+ contingent shares of 20,000 + conversion on bonds of 21000 = 940,000

< the contingent shares are considered while calculating diluted EPS because the condtions of Merills net income is being met currently>

<conversion of bonds is calculated as 600,000 / 1000 x 35=21000>

<exercise of options is calculated as follows:

Ignore stock options of 2017 and 2018 as the share price of those years is not more than the market price of $54

Stock option as of 31 dec 2017: 27000 x 46 / 54 = 23000

Net increase in shares = 27000 - 23000 = 4000>

Diluted EPS = $ 3007,400 / 940,000 = $3.2

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