Session 14 EPS (1) - Class 14: Dilutive Securities and EPS...

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Unformatted text preview: Class 14: Dilutive Securities and EPS Hye Sun Chang ACCY 303 Microsoft 2008 10K Income Statement Microsoft 2008 10K Income Statement Outline Outline • Basic EPS • Diluted EPS • – Stock options, rights and warrants. – Convertible bonds and preferred stocks. Earnings Per Share (EPS) Earnings Per Share (EPS) Of the myriad facts and figures generated Of by accountants, the single accounting number that is reported most frequently in the media and receives by far the most attention by investors and creditors is Earnings Per Share. Earnings Examples of EPS in Media Examples of EPS in Media • CNNMoney.com, Feb 17, 2009 – Wal­Mart said sales had nearly reached $108 billion during the quarter, while earnings, excluding charges, reached 96 cents per share for the three months ended Jan. 31…Wal­ Mart exceeded its own fourth­quarter estimate for a profit of between 91 cents to 94 cents per share. • CFO.com, Mar 2, 2009. – Indeed, AIG's $61.7­billion loss last quarter compared to a $5.3 billion loss during the same quarter in 2007, is reportedly the largest quarterly loss in corporate history. AIG's net loss in 2008 was $99.3 billion, or $37.84 per diluted share. The previous year, the firm had reported a $6.2 billion profit. Basic Earnings Per Share Simple Capital Structure (Basic EPS) Earnings available to common share holders Weighted average outstanding common stock Factor 1: dividends to preferred shareholders. Factor 2: changing of number of shares during the period. Earnings Available to Common Shareholders Earnings Available to Common Shareholders Net income Less: Current period’s cumulative preferred stock dividends (whether or not declared) Less: Noncumulative preferred stock dividends (only if declared). Net income available to common shareholders Earnings Per Share Earnings Per Share A company had 200,000 shares of $50 par value common stock, A company had 200,000 shares of $50 par value common stock, 10,000 shares of 5%, $20 par value cumulative preferred stock, 10,000 shares of 5%, $20 par value cumulative preferred stock, and 30,000 shares of 5%, $10 par value noncumulative preferred and 30,000 shares of 5%, $10 par value noncumulative preferred stock outstanding during the year. Net income after taxes was stock outstanding during the year. Net income after taxes was $1,500,000. No dividends were declared during the year. $1,500,000. No dividends were declared during the year. Earnings available to common shareholders would be Earnings available to common shareholders would be a. $1,500,000 a. $1,500,000 b. $1,485,000 b. $1,485,000 c. $1,490,000 c. $1,490,000 d. $1,475,000 d. $1,475,000 Earnings Per Share A company had 200,000 shares of $50 par value common stock, A company had 200,000 shares of $50 par value common stock, 10,000 shares of 5%, $20 par value cumulative preferred stock, 10,000 shares of 5%, $20 par value cumulative preferred stock, and 30,000 shares of 5%, $10 par value noncumulative preferred and 30,000 shares of 5%, $10 par value noncumulative preferred stock outstanding during the year. Net income after taxes was stock outstanding during the year. Net income after taxes was $1,500,000. No dividends were declared during the year. $1,500,000. No dividends were declared during the year. Earnings available to common shareholders would be Earnings available to common shareholders would be a. $1,500,000 $1,500,000 – (10,000 × 5% × $20 par) a. $1,500,000 b. $1,485,000 b. $1,485,000 c. $1,490,000 Since dividends were not declared, only c. $1,490,000 d. $1,475,000 the cumulative preferred stock dividends d. $1,475,000 are subtracted. Weighted average outstanding common Weighted average outstanding common stock _Issuance of New Shares Weighted average number of common stock outstanding = ∑ {Number of shares outstanding×(# of months outstanding/ 12)} Compute the weighted average number of shares of common stock outstanding. Date 1/1 4/1 10/1 Description Balance Issued Issued No. of Shares 100,000 50,000 10,000 Weighted average outstanding common Weighted average outstanding common stock _Issuance of New Shares Date 1/1 4/1 10/1 Description Balance Issued Issued No. of Shares 100,000 50,000 10,000 100,000 + [50,000 × (9/12)] + [10,000 × (3/12)] = 140,000 140,000 Shares at Jan. 1 New Shares New Shares Weighted average outstanding common Weighted average outstanding common stock_ Reacquired Shares The weighted average number of shares is The weighted average number of shares is The The reduced by the number of reacquired shares, reduced by the number of reacquired shares, ttime-weighted for the ffraction of the year they ime-weighted for the raction of the year they were not outstanding.. were not outstanding not not Compute the weighted average number of shares of common stock outstanding. Date 1/1 4/1 5/1 Description Balance Issued Repurchased shares No. of Shares 100,000 50,000 12,000 Weighted average outstanding common Weighted average outstanding common stock_ Reacquired Shares Date 1/1 4/1 5/1 Description Balance Issued Repurchased shares No. of Shares 100,000 50,000 12,000 100,000 + [50,000 × (9/12)] - [12,000 × (8/12)] = 129,500 129,500 Shares at Jan. 1 New Shares Treasury Shares Weighted average outstanding common Weighted average outstanding common stock_ Stock Dividends and Stock Splits Common shares issued as part of stock dividends and stock splits are treated retroactively as subdivisions of the shares already outstanding at the date of the split or dividend. Weighted average outstanding common Weighted average outstanding common stock_ Stock Dividends and Stock Splits Compute the weighted average number of shares of common stock outstanding. Date 1/1 4 /1 5/1 Description Balance Issued Stock dividend(100%) No. of Shares 100,000 50,000 150,000 100,000 × (2.00) + [50,000 × (9/12) × 2.00] = 275,000 (9/12) 275,000 Shares at Jan. 1 New Shares Stock dividend adjustment Weighted average outstanding common Weighted average outstanding common stock Compute the weighted average number of shares of common stock outstanding. Date 1/1 4 /1 5/1 7/1 Description Balance Issued Stock dividend(100%) Repurchased shares No. of Shares 100,000 50,000 150,000 12,000 100,000 × (2.00) + [50,000 × (9/12) × 2.00] - [12,000 × (6/12)] (9/12) (6/12)] = 269,000 269,000 Diluted Earnings Per share Potentially Dilutive securities: Potentially Dilutive securities: •Stock options, rights, and warrants Stock options, rights, and warrants •Convertible bonds and preferred Convertible bonds and preferred stock stock Complex Capital Structure (dual EPS) Stock Options Convertible securities Treasury stock method If-converted method Dilution/Antidilution Test Options, Rights, and Warrants Options, Rights, and Warrants The ttreasury stock method assumes The reasury stock assumes tthat: hat: 1. The exercise of options occurs as of 1. The exercise of options occurs as of tthe beginning of the period or when the he beginning or when options were issued, if later. options were issued, if later. 2. The exercise of options are used to 2. The exercise of options are used to purchase treasury shares. This method purchase treasury shares. This method usually results in a net increase in usually results a net increase in shares included in the denominator of shares included in the denominator of tthe calculation of diluted earnings per he calculation of diluted earnings per share. share. Proceeds At At average market price price Used to Purchase Purchase treasury shares shares Options, Rights, and Warrants Options, Rights, and Warrants Determine new shares from assumed exercise of stock options. Compute shares purchased for the treasury. Proceeds from assumed exercise Proceeds from assumed exercise Average market price of stock Average market price of stock Compute the incremental shares assumed outstanding. New shares from assumed exercise (1) Less: Treasury shares assumed purchased (2) Net increase in shares outstanding (3) Treasury Stock Method Treasury Stock Method Common stock outstanding was 100,000 shares. Options to purchase 5,000 shares of common stock were outstanding at the beginning of the year. The options can be exercised to purchase stock at $50 per share. The average market price of the stock was $80. The net increase in the dilutive earnings per share denominator is a. 25,000 shares b. 5,000 shares c. 3,125 shares d. 1,875 shares Treasury Stock Method Common stock outstanding was 100,000 shares. Options to purchase 5,000 shares of common stock were outstanding at the beginning of the year. The options can be exercised to purchase stock at $50 per share. The average market price of the stock was $80. The net increase in the dilutive earnings per share denominator is New shares = 5,000 New shares = 5,000 a. 25,000 shares Treasury shares = 3,125 Treasury shares = 3,125 b. 5,000 shares (5,000 × $50) ÷ $80 (5,000 × $50) ÷ $80 c. 3,125 shares Incremental shares = 1,875 Incremental shares = 1,875 d. 1,875 shares (5,000 -- 3,125) (5,000 3,125) Antidilutive Securities Antidilutive Securities • Antidilutive securities, when converted or exercised, may increase, rather than decrease, EPS. • Antidilutive securities are ignored when calculating the diluted EPS. • When do options, rights and warrants become antidilutive? – Net Income (>0): exercise price > market price. – Net Loss (<0): exercise price < market price. Convertible Securities Convertible Securities • The if­converted method is used for Convertible debt and equity securities • The method assumes conversion occurs as of the beginning of the period or date of issuance of the convertible securities, if later. Convertible Securities Convertible Securities The assumed conversion of convertible bonds or preferred stock has two effects on dilutive earnings per share: Increases the denominator by the number of common Increases the denominator by the number of common shares issuable upon conversion. shares issuable upon conversion. Increases the numerator by decreasing after­tax Increases the numerator by decreasing after­tax interest expense on convertible bonds, and dividends interest expense on convertible bonds, and dividends on convertible preferred stock. on convertible preferred stock. Convertible Securities Convertible Securities Dilutive earnings per share may decrease or increase after the assumed conversion. IIf dilutive earnings per share If dilutive earnings per share f If decreases,, tthe securities are dilutive decreases the securities are dilutive decreases the dilutive decreases he dilutive and are assumed converted.. and are assumed converted converted converted If dilutive earnings per share iincreases,, If dilutive earnings per share ncreases the securities are antidilutive and are the securities are antidilutive and are antidilutive antidilutive not considered converted. not considered converted. not not If­Converted Method If­Converted Method Assume net income (after tax) of $500,000, Assume net income (after tax) of $500,000, cumulative convertible preferred stock cumulative convertible preferred stock dividends of $25,000, common stock dividends of $25,000, common stock outstanding of 50,000 shares, and a tax rate of outstanding of 50,000 shares, and a tax rate of 30%. The convertible preferred stock is 30%. The convertible preferred stock is convertible into 5,000 shares of common stock. convertible into 5,000 shares of common stock. Is the convertible preferred stock dilutive? If­Converted Method If­Converted Method EPS without conversion: $500,000 – $25,000 = $9.50 EPS 50,000 shares 50,000 If the preferred stock is converted, we would not have dividends and the number of shares of common stock would increase by 5,000 shares. There is not a tax effect. EPS after assumed conversion: $500,000 – $0 = $9.09 EPS 55,000 shares Dilutive Dilutive If­Converted Method If­Converted Method Assume net income (after tax) of $500,000, convertible bonds with interest expense of $50,000, common stock outstanding of 50,000 shares, and a tax rate of 30%. The bonds are convertible into 2,000 shares of common stock. Are the convertible bonds dilutive? If­Converted Method If­Converted Method EPS without conversion: $500,000 $500,000 = $10.00 EPS 50,000 shares 50,000 If the bonds are converted, net income would increase by If $35,000 (after taxes) and the number of shares of common stock would increase by 2,000 shares. EPS after assumed conversion: $535,000 = $10.29 EPS $10.29 52,000 52,000 shares shares Antidilutive Antidilutive Summary Summary Impact Potential Common Shares Stock options (or warrants, rights) Convertible bonds or notes Convertible preferred Numerator None Add after tax interest Add back dividends declared Denominator Add incremental shares Add shares issuable upon conversion Add shares issuable upon conversion Order of Entry for Multiple Order of Entry for Multiple Convertible Securities. • Our goal is to reveal the maximum potential dilution that might result. • Calculate the incremental dilutive effect of each security. • Include the securities with most incremental dilutive effect first, then move on to include less dilutive securities. • An anti­dilutive test should be performed after inclusion of each security. Example Example Is EPS A Meaningful Number? Is EPS A Meaningful Number? • Which firm performed better? ...
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