©Cambridge Business Publishers, 2008
Solutions Manual, Module 5
M5-19 (15 minutes)
a. Basic earnings per share is computed as net income less any preferred
dividends, divided by the weighted average number of common shares
outstanding for the period.
The diluted earnings per share calculation includes the effect of dilutive
securities (such as convertible debt securities or employee stock
options) in the denominator and adjusts for any effects of conversion or
exercise in the numerator.
Consequently, diluted earnings per share is always less than or equal to
basic earnings per share.
b. Shares (denominator): For the shares computation, Lucent has 4,426
million weighted average common shares outstanding, and “potentially”
5,218 million shares outstanding for the diluted EPS computation. The
additional 792 million weighted average dilutive common shares (5,218 –
4,426) relate to employee stock options, stock warrants (similar to
options), and convertible securities (such as convertible debt and
convertible preferred stock) that potentially could be converted into
Income (numerator): For the income computation, Lucent’s net income
is $1,185 for the basic EPS computation. Lucent’s income is $86 higher,
or $1,271, for the diluted EPS computation.
$1,185 / 4,426 shares
Diluted EPS = $1,271 / 5,218 shares = $0.24
c. Diluted EPS assumes that all convertible securities are converted at the
beginning of the year (or when issued if issued during the year). If the
debt was converted into common stock, Lucent would not have
recorded interest expense relating to the convertible securities. Thus,
pretax income and tax expense would both have been higher. The $86
million, is the after-tax income interest expense, which is added to
Lucent’s reported profit in the EPS computation.