Ch 09 FIN4345

Ch 09 FIN4345 - Chapter 9 For the Investor QUESTIONS 9- 1....

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269 Chapter 9 For the Investor QUESTIONS 9- 1. Earnings per share is the amount of income earned on a share of common stock during an accounting period. 9- 2. The Financial Accounting Standards Board suspended the reporting of earnings per share for nonpublic companies. 9- 3. Keller & Fink is a partnership. Earnings per share is a concept that only applies to corporate income statements. 9- 4. Earnings per share is a concept that only applies to common stock. The earnings per common share computation only uses earnings available to common stockholders. To arrive at the income that applies to common stock, preferred dividends are subtracted from net income in the numerator of the ratio. 9- 5. Since earnings pertain to an entire year, they should be related to the common shares outstanding during the year. The year-end common shares outstanding may not be representative of the shares outstanding during the year. 9- 6. Less preferred dividends will be subtracted from net income in the numerator of the earnings per share computation. This will increase earnings per share. In practice, whether earnings per share will be increased or decreased depends on the after-tax earnings that the firm would have from the funds used to retire the preferred stock in relation to the dividend decrease. 9- 7. Stock dividends and stock splits do not provide the firm with more funds; they only change the number of outstanding shares. Earnings per share should be related to the outstanding common stock after the stock dividend or stock split. 9- 8. Many firms try to maintain a stable percentage because they have a policy on the percentage of earnings that they want retained for internal growth. 9- 9. Financial leverage is the use of financing with a fixed charge. Financial leverage will magnify changes in earnings available to the common shareholder. Its use is advantageous when a firm obtains a greater return on the resources obtained than the rate of interest expense. Its use is disadvantageous when a firm obtains a lower return on the resources obtained than the rate of interest expense.
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270 9-10. If the interest rate rises, the degree of financial leverage will rise. For example, suppose the firm has the following pattern of earnings with $1,000,000 in long-term debt: Earnings before interest and tax $1,000,000 Interest ($1,000,000 at 8%) (80,000) Earnings before tax $ 920,000 Degree of Financial Leverage = Income Before Interest and Tax Earnings before tax = $1,000,000 $920,000 = 1.09 If the rate of interest rises to 12%, then the degree of financial leverage will be as follows: Earnings before interest and tax $ 1,000,000 Interest ($1,000,000 at 12%) 120,000 Earnings before tax $ 880,000 Degree of financial leverage = $ 1,000,000 880,000 = 1.14 The degree of financial leverage has risen. 9-11.
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This note was uploaded on 08/28/2011 for the course FIN 4345 taught by Professor Moysidis during the Fall '10 term at FIU.

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Ch 09 FIN4345 - Chapter 9 For the Investor QUESTIONS 9- 1....

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