On December 31, 2017, Berclair Inc. had 320 million shares of common stock and 5

Question

On December 31, 2017, Berclair Inc. had 320 million shares of common stock and 5 million shares of 9%, $100 par value cumulative preferred stock issued and outstanding. On March 1, 2018, Berclair purchased 24 million shares of its common stock as treasury stock. Berclair issued a 5% common stock dividend on July 1, 2018. Four million treasury shares were sold on October 1. Net income for the year ended December 31, 2018, was $350 million. The income tax rate is 40%.

Also outstanding at December 31 were incentive stock options granted to key executives on September 13, 2013. The options are exercisable as of September 13, 2017, for 30 million common shares at an exercise price of $56 per share. During 2018, the market price of the common shares averaged $70 per share.

In 2014, $62.5 million of 8% bonds, convertible into 6 million common shares, were issued at face value.

Required:

Compute Berclair’s basic and diluted earnings per share for the year ended December 31, 2018.

Explanation / Answer

Solution :

Basic EPS

To determine the weighted average common shares outstanding:

SHARES ISSUED                            Time outstanding                                             Total (in millions)

320                                        12/12 (J an 1 - December 31st) = 320*1.05 =               336

-24                               10/12 (March 1 - December 31st) =-20*1.05 =                      -21

4                                      3/12 October 1 - December 31)                                              1

                                   Weighted average common shares                                 316 million

To compute the preferred dividend:

5 million * $100 * 9% = 45 million

Therefore Basic EPS:

= 350 million - 45 million = $ 0.97

       316 million

Since the stock options were not actually exercised, they are not adjusted to the basic EPS figure.

Diluted EPS

With diluted EPS, we show what the EPS would be if all of the dilutive securities are converted to common stock. In this case, we are giving investors a view of what the "worst case scenario" would be to earnings if all of the shares possible were converted to common shares.

When computing the Diluted EPS, we use the "If-converted" method, which assumes all dilutive securities are converted as soon as they are issued, regardless of if or when they are actually converted.

In this problem, the potentially dilutive securities are the stock options.

To determine the treasury shares:

30 million shares X $ 56 exercise price = $1,680 million

$1,680 million/ $70 market price= 24 million shares.

The calculation of diluted EPS assumes that the shares specified by stock options were issued at the exercise price and that the proceeds were used to buy back (as treasury stock) as many of those shares as can be purchased at the market price during the period.

Therefore, the incremental shares that result from the stock options would be:

30 million - 24 million = 6 million

The stock options were outstanding throughout the entire year, so we do not weight this amount.

There was no change to the numerator figure, so our Diluted EPS is:

Basic EPS: 350 million - 45 million = $0.95

                     316 million + 6 million

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