On December 31, 2017, Dow Steel Corporation had 650,000 shares of common stock a
ID: 2521227 • Letter: O
Question
On December 31, 2017, Dow Steel Corporation had 650,000 shares of common stock and 35,000 shares of 9%, noncumulative nonconvertible preferred stock issued and outstanding. Dow issued a 5% common stock dividend on May 15 and paid cash dividends of $450,000 and $74,000 to common and preferred shareholders, respectively, on December 15, 2018 On February 28, 2018, Dow sold 64,000 common shares. Also, as a part of a 2017 agreement for the acquisition of Merrill Cable Company, another 26,000 shares (already adjusted for the stock dividend) are to be issued to former Merrill shareholders on December 31, 2019, if Merrill's 2019 net income is at least $550,000. In 2018, Merrill's net income was $680,000 In keeping with its long-term share repurchase plan, 7,000 shares were retired on July 1. Dow's net income for the year ended December 31, 2018, was $2,350,000. 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 December 31, 2016 December 31, 2017 December 31, 2018 Options Granted (adjusted for the stock dividend) 12,000 7,000 10,500 Share Price $ 16 $ 24 25 The market price of the common stock averaged $24 per share during 2018 On July 12, 2016, Dow issued $900,000 of convertible 10% bonds at face value. Each $1,000 bond is convertible into 30 common shares (adjusted for the stock dividend). Requirec Compute Dow's basic and diluted earnings per share for the year ended December 31, 2018. (Enter your answers in thousands.) Numerator DenominatorEarnings per share Dow's basic Dow's dilutedExplanation / Answer
Basic EPS:
Numerator: Net Income = $2,350,000
Preferred Divedend = $74,000 (because the preferred stock is noncumulative, only include the dividends that are actually paid)
Denominator: Weighted average number of shares of common stock outstanding:
1/1 - 31/12 : 650,000 * (12/12) = 650,000 * 1.05 = 682,500
28/2 - 31/12 : 64,000 * (10/12) = 53,333.33 * 1.05 = 56,000
1/7 - 31/12 : 7,000 * (6/12) = (3,500)
Weighted average number of shares = 735,000
Basic EPS = (Net Income - Preferred dividend) / Weighted average number of shares
= (2,350,000 - 74,000) / 735,000
= 2,276,000 / 735,000 = 3.1 Ans.
Diluted EPS:
Calculation of Diluted shares:
12,000 options issued 12/31/16 with exercise price of $16.
1. It is dilutive because the exercise price of $16 < market price of $24. Assume exercise at the later of the date of issue (12/31/16) or the beginning of the year (1/1/17).
2. Proceeds received upon exercise ($16 x 12,000) = $192,000
3. Shares repurchased at current market price = $192,000 ÷ $24 = 8,000
4. Net Increase in number of shares = 12,000 - 8,000 = 4,000
7,000 options issued 12/31/17 with exercise price of $25.
1. They are not dilutive because the exercise price $25 is not less than the market price of $24. Therefore we would ignore this option.
10,500 options issued 12/31/18 with exercise price of $24.
1. They are not dilutive because the exercise price of $24 is not less than the market price of $24. Therefore we would ignore this option.
Diluted shares = (Net Income - Preferred dividend) / (Weighted average number of shares + Diluted shares)
= (2,350,000 - 74,000) / (735,000 + 4,000)
= 2,276,000 / 739,000
= 3.08 Ans.
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