You are an accountant for ABC Corporation, currently a privately-held corporatio
ID: 2585526 • Letter: Y
Question
You are an accountant for ABC Corporation, currently a privately-held corporation. To finance a future expansion with the potential of becoming a publicly-traded corporation, the board of directors is considering the issuance of stock to the existing stockholder group and the issuance of convertible securities to the general public. They know that if they eventually do go public, the investment community will use metrics like EPS to assess the price to pay for the stock. They are quite concerned about how the company’s EPS numbers would compare to those of their competitors under this new proposal.
Here are the transactions that are under consideration for 2017:
June 1 Issue 6%, $1,000 bonds at a total price of $5 million. Each $1,000 certificate is convertible into 100 shares of common stock. The par value and market value of the convertible bonds are the same.
July 15 Issue 300,000 shares of common stock at $3 per share.
August 1 Issue 20,000 shares of 5% cumulative preferred stock ($150 par), with each share convertible into 19 shares of common stock. The annual 5% dividend payment is paid on December 31 and will be prorated for the length of time the stock has been outstanding. The stock would be issued at par.
October 1 Issue 200,000 shares of common stock for $3 per share.
December 1 Issue 100,000 shares of common stock for $3 per share.
No doubt this is an ambitious plan. Although there are a number of questions regarding the assumptions in the plan, the Board would first like to know the potential impact on earnings per share.
Note that the company started the year with 440,000 common shares issued and outstanding.
Instructions
explain the differences between basic and diluted earnings per share.
Include in the memo calculations for both basic and diluted earnings per share given the new capital structure following this financing plan. The forecasted net income (after the bonds and new stock have been issued) for 2017 is $331,500. The tax rate for ABC Corp. is 35%. Be sure these calculations and your final answers are clearly presented.
Explanation / Answer
June 1 Issue 6%, $1,000 bonds at a total price of $5 million. Each $1,000 certificate is convertible into 100 shares of common stock. The par value and market value of the convertible bonds are the same. July 15 Issue 300,000 shares of common stock at $3 per share. August 1 Issue 20,000 shares of 5% cumulative preferred stock ($150 par), with each share convertible into 19 shares of common stock. Dividends are paid on the preferred stock on June 30 and December 31 of each year. The stock would be issued at par. October 1 Issue 200,000 shares of common stock for $3 per share. December 1 Issue 100,000 shares of common stock for $3 per share. Compute diluted earnings per share and basic earnings per share given the new capital structure following this financing plan. The forecasted net income for 2016 is $331,500, and the tax rate is 35%. Note – The net income forecast includes the interest expense on the bonds that are to be issued June 1. June 1 Issue 6%, $1,000 bonds at a total price of $5 million. Each $1,000 certificate is convertible into 100 shares of common stock. The par value and market value of the convertible bonds are the same. Adjusted Net Income Additional Outstanding shares Additional Common Shares = ($5,000,000/$1000)* 100 shares 5,00,000 shares Bond Interest = $5,000,000 *6% =$300,000 $195,000.00 After tax interest ($300,000 *(1-35%)=$195,000 July 15 Issue 300,000 shares of common stock at $3 per share. 3,00,000 shares August 1 Issue 20,000 shares of 5% cumulative preferred stock ($150 par), with each share convertible into 19 shares of common stock. Dividends are paid on the preferred stock on June 30 and December 31 of each year. The stock would be issued at par. Additional Common Shares = 20,000 shares *19 shares 3,80,000 shares Preferred Dividends (20,000*150*5%) $150,000.00 Since dividends are not tax deductible, there are no tax implications. October 1 Issue 200,000 shares of common stock for $3 per share. 2,00,000 shares December 1 Issue 100,000 shares of common stock for $3 per share. 1,00,000 shares Basic EPS = Adjusted Net Income without conversion/ Weighted Average Shares Outstanding without conversion BAsic EPS = $331,500/(300,000+200,000+100,000) $0.66 per share Diluted EPS = Adjusted Net Income on conversion/ Weighted Average Shares Outstanding on conversion Adjusted Net income($331,500+$150,000+$195,000) $676,500.00 Weighted average shares outstanding on conversion = (300,000+200,000+100,000+380,000+500,000) 14,80,000 shares Diluted EPS = $676,500/1,480,000 $0.46 per share
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.